THE  LIBRARY 

OF 

THE  UNIVERSITY 
OF  CALIFORNIA 

LOS  ANGELES 


Graduate 


California 


Principles  of  Auditing 


BY 

JOHN  RAYMOND  WILDMAN,  M.C.S.,  CP.A. 

Professor  of  Accounting  in  New  York  University 


1920 
THE  WILLIAM  G.  HEWITT  PRESS 

61-67  NAVY   STREET,    BROOKLYN,   NEW   YORK 

40100 


Copyright,  1916 

BY 
JOHN  RAYMOND  WILDMAN 


Bus.  Admin. 
Library 


HP 


DEDICATED 

TO 

MR.   ELIJAH  WATT  SELLS 

PIONEER,    AUTHORITY 
GENTLEMAN 


FOREWORD 

A  young  man   came   to   New   York   with   the   intention   of 
^*      entering  the  profession  of  accountancy.     He  was  energetic  and 
>       ambitious;  had  a  good  general  education  and  some  experience 
^      in  accounting  work.     He  obtained  employment  with  a  firm  of 
certified  public  accountants.     The  usual  grind  of  footing  and 
^      checking  followed  for  a  while;  always  under  the  direction  of 
the  man  in  charge  of  the  engagement.     Finally  came  the  long 
sought  chance  to  go  out  on  an  engagement  alone.     He  received 
fJt      no  instructions ;  in  fact  he  never  had  received  any  instructions 
about  how  the  work  should  be  done.    What  he  had  learned  had 
>.      been  learned  by  observation.     He  had  been  afraid  to  ask  ques- 
4  -      tions  for  fear  such  procedure  would  create  the  suspicion  that  he 
did  not  know  as  much  about  his  work  as  he  should.     For  the 
t\      same  reason  when  sent  on  the  engagement  alone  he  did  not  ask 
for  working  papers  and  reports  which  would  serve  as  guides. 
jThe  result  of  his  work  almost  proved  disastrous.     Conscientious 
and  careful  as  the  work  had  been  the  report,  although  prepared 
with  great  pains,  was  not  in  the  form  used  by  the  firm.     When 
it  was  reviewed  by  the  report  department  it  was  not  only  torn 
to  pieces  and  made  over  but  the  accountant  was  held  up  to  ridi- 
cule before  a  number  of  persons  who  happened  to  be  in  the  room. 
This  unfortunate  experience  would  have  broken  the  spirit  of 
some  men.     In  this  case  it  only  served  to  hash  the  subject  into 
a  frenzied  determination  to  succeed  in  the  field  of  endeavor  which 
he  had  chosen. 

How  he  toiled  far  into  the  night  for  several  years  while 
carrying  on  his  daily  work,  at  the  same  time  getting  a  technical 
education,  as  well  as  some  of  his  many  and  varied  experiences, 
might  make  an  interesting  story  but  they  have  no  place  here. 
Some  of  the  things  he  was  never  able  to  find  in  books  and  about 
which  he  was  too  proud  to  ask  are  set  forth  in  this  book. 

It  is  dedicated  to  a  man  who  represents  all  that  is  fine  and 
noble  in  a  professional  man ;  one  who  cannot  help  but  be  an 
inspiration  to  all  who  come  in  contact  with  him. 


FOREWORD 

The  author's  one  regret  is  that  the  book  is  not  more  thorough 
and  polished  on  account  of  the  man  to  whom  it  is  dedicated; 
his  one  hope  that  it  may  lend  a  helping  hand  to  some  young 
man  struggling  along  the  rocky  road  that  leads  to  success. 

JOHN  RAYMOND  WILDMAN. 
New  York  University, 
February  1,  1916. 


CONTENTS 


CHAPTER  PAGE 

I    Auditing  Defined I 

II    The  Occasions  for  Auditing 3 

III  The  Occasions  for  Auditing — Continued 8 

IV  Audits  Differentiated  from  Examinations  and  Investigations     13 
V    The   Engagement 16 

VI    What  to  Do  Before  Beginning  an  Audit 21 

VII    Counting  the  Cash 33 

VIII    Counting  the  Notes  and  Securities 42 

IX    Taking  Off  the  Trial  Balance 48 

X    Reading   the   Minutes 61 

XI    The  Mechanical  Work 66 

XII    Reconciling  the  Bank  Account 78 

XIII  Vouching  the  Disbursements 86 

XIV  The  Petty  Cash 96 

XV    Vouching  the  Purchase  Journal  or  Voucher  Register 102 

XVI    Inventories    108 

XVII    Analyzing   Accounts 121 

XVIII     Some  Accounts  Which  Require  Analysis 130 

XIX    The  Customers  Ledger 135 

XX    Other  Accounts  Which  Require  Attention 142 

XXI    Accounts  on  the  Credit  Side 148 

XXII    How  to  End  an  Audit 159 

XXIII    What  to  Do  After  an  Audit 165 


Principles  of  Auditing 


CHAPTER  I 

AUDITING  DEFINED 

Auditing  is  required  because  someone  may  through  ignorance, 
carelessness  or  intent,  have  failed  to  record,  express  or  report, 
carefully  and  accurately,  facts  concerning  financial  transactions. 
If  no  one  were  ignorant,  or  careless,  or  had  bad  intentions,  or 
there  was  no  lack  of  confidence  on  the  part  of  any  one,  probably 
one  half  of  the  occasions  for  auditing  would  be  removed.  If  all 
facts  concerning  financial  transactions  were  carefully  and  accu- 
rately recorded  and  expressed  and  reported  it  is  almost  safe  to  say 
that  the  other  one  half  of  occasions  in  which  auditing  is  required 
would  be  removed.  The  familiar  expression  "to  err  is  human"  is 
especially  applicable  in  the  case  of  auditing.  All  are  prone  to 
make  mistakes.  Auditing  then  practically  means  searching  for 
mistakes;  reviewing  the  work  of  others  in  an  effort  to  discover 
errors.  It  might  be  more  charitable  perhaps  to  say  that  auditing 
is  reviewing  the  work  of  others  in  an  effort  to  prove  its  correct- 
ness. The  kind  of  an  auditor  which  one  is  to  become  will  depend 
perhaps  very  largely  on  which  attitude  one  assumes,  namely, 
searching  for  the  mistakes  of  others  or  trying  to  prove  the  cor- 
rectness and  accuracy  of  the  work  examined. 

Auditing  is  not  accounting  nor  is  it  accountancy.  Accounting 
is  the  science  which  treats  of  the  systematic  record,  compilation 
and  presentation  in  a  comprehensive  manner  for  purposes  of  ad- 
ministration, or  the  information  of  other  parties  at  interest,  of  the 
facts  concerning  the  financial  operations  of  a  business  or  other 
organization. 

Accountancy  is  most  aptly  defined  in  the  Certified  Public  Ac- 
countant syllabus  issued  by  the  New  York  State  Education  De- 
partment as  "a  profession,  the  members  of  which,  by  virtue  of 
their  general  education  and  professional  training,  offer  to  the 
community  their  services  in  all  matters  having  to  do  with  the 
recording,  verification  and  presentation  of  facts  involving  the 


PRINCIPLES  OF  AUDITING 

acquisition,  production,  conservation  and  transfer  of  values.  "Ac- 
countancy comprehends  the  conduct  of  audits,  examinations  and 
investigations ;  devising  and  installing  systems ;  criticising  organi- 
zations and  management;  and  in  some  cases  efficiency  work." 

Auditing  is  therefore  seen  to  be  a  branch  of  accountancy,  which 
profession  is  as  much  broader  in  its  scope  than  auditing  is  in  turn 
broader  in  scope  than  accounting.  To  perform  the  functions  of 
an  auditor  intelligently  and  successfully,  one  must  have  a  thorough 
knowledge  of  accounting. 

Auditing  may  be  defined  as  the  art  of  reviewing  the  work  inci- 
dent to  the  record,  compilation  and  presentation  of  the  facts  con- 
cerning financial  transactions.  Auditing,  it  will  be  noted,  is  said 
to  be  an  art.  With  regard  to  accounting  it  was  said  to  be  a 
science.  Auditing  is  referred  to  as  an  art  because  it  has  a  set  of 
rules.  If  one  were  able  to  conceive  of  all  the  possibilities  in  audit- 
ing it  is  probable  that  a  set  of  precise  rules  could  be  laid  down 
which  would  be  sufficiently  comprehensive  to  enable  an  intelligent 
person  with  a  knowledge  of  accounting  to  do  everything  that  is 
necessary  to  be  done  in  auditing.  For  example,  there  being  a 
possibility  of  error  in  the  footing  of  a  column  of  figures,  if  one 
wishes  to  determine  whether  or  not  the  footing  is  correct,  it  is 
only  necessary  to  re-foot  the  column.  If  it  were  desired  to  ascer- 
tain the  correctness  of  certain  cost  statistics,  such  as  the  cost  per 
ton  of  a  certain  amount  of  coal  mined,  having  the  facts  as  to  the 
cost  of  the  coal  and  the  mining  thereof  and  the  number  of  tons 
mined,  a  rule  for  accomplishing  the  purpose  would  consist  in 
instructions  to  divide  the  cost  of  the  coal  by  the  number  of  tons. 
There  is  no  disputing  the  fact  that  it  requires  ingenuity  and  judg- 
ment to  become  a  good  auditor.  That  matter  is,  however,  quite 
apart  from  the  distinction  between  accounting  as  a  science  and 
auditing  as  an  art. 

Auditing  may  be  professional  or  non-professional.  Which  it 
is  depends  very  largely  upon  the  auditor.  If  he  offers  his  services 
to  the  public,  it  is  professional  auditing.  If  he  confines  his  efforts 
to  one  organization,  it  is  non-professional  auditing. 


CHAPTER  II 

THE  OCCASIONS  FOR  AUDITING 

Modern  business  organizations  in  a  great  number  of  instances 
have  become  so  great  and  so  complex  as  to  have  passed  beyond 
the  limit  of  observation  of  the  individual.  It  is  impossible  as  a 
rule  for  the  president  of  a  company  or  the  proprietor  of  a  business 
to  be  in  touch  personally  with  what  is  going  on  in  every  division 
or  department  of  his  organization.  One  striking  exception  to  this 
rule  is  the  case  of  a  young  man  in  New  York  City,  who  is  the 
proprietor  of  a  concern  engaged  in  the  manufacture  and  sale  of 
ladies'  neckwear.  The  concern  occupies  one  entire  floor  of  a  loft 
building  in  a  section  of  the  city  where  similar  concerns  are  found. 
The  plant,  altho  a  comparatively  small  one,  is  organized  and 
arranged  on  a  scientific  basis.  The  receiving,  stock,  manufac- 
turing, and  the  shipping  departments  are  so  arranged  as  to  facili- 
tate the  proper  routing  of  the  work.  The  office  and  sales  rooms 
are  accessible  to  all  persons  who  have  dealing  with  the  concern. 
The  proprietor  has  his  desk  on  a  raised  platform  in  the  centre 
of  the  plant  so  that  by  turning  about  in  his  revolving  chair  he  is 
able  at  all  times  to  see  what  is  going  on  in  all  parts  of  the  plant. 
If  there  is  congestion  in  the  manufacturing  department  or  in  the 
shipping  department  he  knows  about  it  at  once  and  may  see  that 
the  goods  are  moved  along.  If  trouble  arises  in  connection  with 
some  machine  it  is  brought  to  his  attention  immediately  and  the 
trouble  is  remedied  without  loss  of  time.  When  goods  are  re- 
ceived he  is  in  a  position  to  see  that  they  are  unpacked,  counted 
and  put  in  stock;  that  requisitions  are  filled  promptly  and  that 
the  stock  is  kept  up.  This  arrangement  is,  of  course,  an  ideal 
one  and  a  striking  example  of  an  individual  who  is  in  touch 
personally  with  all  the  ramifications  of  the  business. 

By  way  of  comparison  it  may  be  of  interest  to  try  and  imagine 
the  president  of  the  United  States  Steel  Corporation  with  its  thirty 
or  forty  plants  endeavoring  to  follow  out  the  same  scheme.  It 
will  thus  be  seen  how  impossible  in  many  cases  it  is  for  the  chief 
executive  to  be  in  personal  touch  with  all  that  is  going  on.  Such 
an  individual  requires  some  artificial  means  of  bringing  into  his 
office  a  picture  of  what  is  going  on  throughout  the  organization; 

3 


PRINCIPLES  OF  AUDITING 

something  which  will  enable  him  to  visualize  the  situation.  Ac- 
counting is  one  of  the  artificial  means  which  enables  such  men 
to  overcome  these  difficulties  of  time,  space  and  distance,  and  to 
carry  on  the  work  of  administration  from  the  results  concerning 
the  financial  operations  which  are  supplied  to  them  from  time  to 
time. 

The  question  may  now  arise  as  to  whether  such  individual  will 
accept  the  information  which  is  presented  to  him  and  act  upon  it 
without  question.  The  probabilities  are  that  he  will,  if  the  organi- 
zation is  a  small  one  where  he  knows  personally  the  man  who 
prepares  the  report  or  furnishes  him  with  the  information.  If 
the  organization  is  of  any  size  the  chances  are  that  he  will  not 
accept  and  act  on  the  information  without  taking  some  steps  to 
satisfy  himself  as  to  its  accuracy.  There  are  probably  many 
reasons  why  he  would  not  attend  to  this  matter  in  person.  One 
reason  may  be  that  he  is  too  busy  to  go  out  and  check  up  the  in- 
formation himself,  and  in  other  instances  he  is  not  competent  to 
do  it  because  he  does  not  know  where  the  information  came  from 
and  how  it  was  compiled  nor  where  the  records  from  which  it 
was  taken  are  kept.  A  further  reason  may  be  that  the  president 
is  too  high-priced  an  employe  to  spend  his  time  in  work  of  this 
nature.  Accordingly  he  makes  use  of  someone  at  his  command. 
As  a  rule  he  sends  someone  else  to  do  the  work  for  him.  He 
sends  someone  that  he  can  trust  and  someone  that  is  competent 
to  do  the  work.  Since  these  are  the  results  produced  by  account- 
ing, it  naturally  follows  that  he  must  send  someone  to  verify  the 
results  who  understands  accounting  in  all  its  details.  The  re- 
lation is  confidential  and  the  person  sent,  who  has  the  function  of 
auditor,  is  his  personal  representative. 

Generally  speaking  it  may  be  said  that  auditing  is  done,  first, 
to  satisfy  someone  as  to  the  correctness  of  the  accounts ;  second, 
to  prove  or  disprove  some  contention;  third,  to  influence  pros- 
pective purchasers  of  goods  or  proprietary  interests,  and  pros- 
pective creditors. 

While  the  occasions  for  auditing  are  numerous  and  varied, 
they  are  probably  all  comprehended  in  the  following  category: 

A.    At  the  instance  of  someone  within  the  organization. 

1.  To  satisfy  someone  within 

2.  To  satisfy  someone  without 


THE    OCCASIONS    FOR    AUDITING 

3.  To  prove  or  disprove  some  contention  on  the  part 

of  someone  within 

4.  To  prove  or  disprove  some  contention  on  the  part 

of  someone  without 

5.  To  influence  someone  within 

6.  To  influence  someone  without 

B.    At  the  instance  of  someone  without  the  organization. 

1.  To  satisfy  someone  without 

2.  To  prove  or  disprove  some  contention  on  the  part 

of  someone  without 

3.  To  influence  someone  without 

The  specific  occasions  may  now  be  considered  in  the  order  in 
which  they  would*  appear  in  accordance  with  their  relation  to  the 
above  category. 

First,  at  the  instance  of  someone  within  the  organization  to 
satisfy  someone  within. 

A  sole  proprietor  may  frequently  be  at  the  head  of  a  business 
which  is  sufficiently  large  to  require  a  more  or  less  elaborate 
organization.  It  is  probable  that  except  in  rare  cases  such  indi- 
vidual will  have  someone  to  keep  the  accounts  for  him  and  that 
he  has  not  the  time,  patience  or  training  to  check  up  such  work 
himself  and  will  probably  realize  the  necessity  sooner  or  later  of 
employing  someone  to  audit  the  accounts  for  him  in  order  that 
he  may  be  satisfied  as  to  their  correctness. 

In  the  case  of  co-partnership  the  services  of  an  auditor  are 
perhaps  more  frequently  apt  to  be  required  because  of  the  neces- 
sity for  accuracy  in  the  determination  of  profits.  Since  partners 
are  interested  in  the  sharing  of  profits  it  is  of  mutual  importance 
to  them  that  the  profits  be  correctly  stated.  Here  it  is  that  the 
auditor  is  frequently  needed,  not  only  for  the  purpose  of  giving 
his  independent  opinion  as  to  the  results  under  normal  conditions, 
but  also  in  case  of  dispute  between  or  among  partners.  Parties 
to  a  joint  venture  which  is  a  special  form  of  partnership  except 
that  the  parties  combine  their  money  or  efforts  in  connection  with 
one  particular  piece  of  business  rather  than  a  series  of  miscel- 
laneous business  transactions  extending  over  a  period,  are  de- 
sirous of  knowing  whether  or  not  the  accounts  are  correct  and 
whether  the  profits  are  properly  stated  in  order  that  each  party 
may  know  whether  or  not  he  is  getting  his  proper  share. 

5 


PRINCIPLES  OF  AUDITING 

Associations  or  societies  supported  by  membership  dues  or 
contributions  require  the  services  of  an  auditor  in  order  that  the 
supervising  or  directing  heads  who  are  responsible  for  the  affairs 
of  the  organization  may  know  that  the  funds  have  been  properly 
handled  and  accounted  for  and  in  order  that  proper  reports  may 
be  made. 

Officers  and  directors  of  corporations  probably  have  more  fre- 
quent and  greater  need  for  the  services  of  an  auditor  than  any 
other  type  of  organization.  This  is  occasioned  by  the  elaborate 
division  and  departmental  organization  which  is  apt  to  exist  under 
such  organizations.  Written  reports  are  made  use  of  to  an  ex- 
tensive degree.  Each  employe  or  group  of  employes,  or  depart- 
ment, is  in  turn  reporting  to  someone  higher  up.  Officers  and 
department  heads  are  constantly  having  occasion  to  receive  re- 
ports from  subordinates.  The  geographical  location  of  various 
plants  or  activities  of  the  same  organization  make  it  all  the  more 
necessary  that  reports  be  depended  upon.  It  is  undoubtedly  in 
connection  with  the  work  of  corporations  that  the  auditor,  both 
professional  and  non-professional,  finds  the  most  frequent  need 
for  his  services. 

Analogous  to  this  situation  is  that  in  which  supervising  en- 
gineers and  companies  which  finance  and  manage  public  utilities, 
employ  a  staff  of  non-professional  auditors  for  the  purpose  of 
auditing  the  accounts  of  operating  companies  over  which  their 
supervision  extends. 

Second,  at  the  instance  of  someone  within  the  organization  to 
satisfy  someone  without. 

While  there  is  a  theory  to  the  effect  that  stockholders  are  pro- 
prietors and  that  like  sole  proprietors  or  co-partners  they  have  a 
voice  in  the  management  of  the  business,  it  is  probable  that  such 
is  not  actually  the  case  except  in  a  few  instances.  The  average 
stockholder  probably  invests  his  money  and  takes  his  dividends  if 
he  can  get  them  with  little  thought  as  to  his  rights  of  manage- 
ment, except  as  he  may  present  himself  or  his  proxy  at  some  annual 
or  other  meeting  of  stockholders.  It  is  probably  not  an  extrava- 
gant statement  to  say  that  in  the  majority  of  cases  stockholders 
are  considered  from  the  point  of  view  of  the  management  as  being 
outsiders  who  contribute  funds  with  which  in  part  to  carry  on  the 
business.  Such  at  least  is  the  status  of  the  stockholder  in  his 
relation  to  the  management  under  the  above  category,  and  while 

6 


THE    OCCASIONS    FOR    AUDITING 

some  liberty  may  have  been  taken  in  so  doing  nothing  serious  is 
thought  to  be  at  stake. 

The  officers  report  to  the  directors  and  the  directors  report  to 
the  stockholders.  It  is  therefore  thought  quite  important  by  the 
directors  of  many  corporations  that  a  complete  and  comprehensive 
report  of  the  affairs  entrusted  to  their  care  should  be  made  to  the 
stockholders,  and  that  such  report  should  have  the  approval  of 
some  qualified  independent  person  before  being  submitted  to  the 
stockholders.  Since  such  reports  cover  very  largely  the  financial 
transactions,  it  is  obviously  necessary  that  before  such  report  may 
be  approved  by  an  auditor,  that  an  audit  of  the  accounts  shall  be 
made. 


CHAPTER  III 

THE  OCCASIONS  FOR  AUDITING — CONTINUED 

The  same  kind  of  information  which  would  be  interesting  to 
stockholders  would  be  interesting  also  to  bondholders.  Bond- 
holders might  have  to  be  satisfied  in  certain  instances  by  means 
of  an  audit.  In  this  same  class  of  outsiders  would  be  included 
creditors  in  general,  and  banks  in  particular.  Creditors  who  have 
large  accounts  may  be  thought  worthy  of  satisfaction  through  an 
audit.  Likewise,  it  may  be  considered  desirable  to  satisfy  banks 
which  have  large  amounts  of  commercial  paper  of  any  given 
concern,  or  banks  which  have  applications  for  loans  which  it 
is  desired  they  shall  make.  The  position  of  any  company  or 
organization  seeking  credit  is  always  very  much  stronger  if  the 
statements  presented  are  supported  by  certificates  of  auditors. 
Following  out  the  same  idea  there  are  frequently  seen  in  the  daily 
newspapers  published  reports  of  insurance  companies  which  pre- 
sumably are  given  out  for  the  purpose  of  assuring  policyholders 
that  the  business  is  being  properly  conducted  and  that  the  ac- 
counts have  been  audited  and  found  correct.  In  all  of  the  above 
cases  the  occasion  for  the  audit  arises  at  the  instance  of  someone 
within  the  organization  in  an  attempt  to  satisfy  someone  without. 

Third,  at  the  instance  of  someone  within  the  organisation  to 
prove  or  disprove  some  contention  on  the  part  of  someone  withil . 

In  this  connection  it  may  be  noted  that  disputes  have  been 
known  to  arise  among  the  officers  as  to  the  honesty,  capability 
or  efficiency  of  employes  who  have  to  do  with  the  accounts.  Al- 
most any  professional  auditor  of  experience  will  recall  disputes 
which  have  arisen  between  some  of  the  officers  on  the  one  hand 
and  a  plant  manager  or  superintendent  on  the  other.  The  dis- 
cussion usually  consists  of  an  argument  as  to  whether  certain 
items  constitute  charges  to  capital  or  to  expense.  The  manager 
is  usually  trying  to  make  a  record  by  keeping  down  the  expense, 
and  attempts  wherever  possible  to  charge  questionable  items  to 
capital.  The  officers,  on  the  other  hand,  are  endeavoring  to 
guard  against  having  an  eggshell  plant  built  up,  the  account  for 
which  will  be  full  of  charges  for  intangible  values  which  should 
e  charged  to  expense.  Audits  are  frequently  occasioned  by  the 

8 


THE    OCCASIONS    FOR    AUDITING 

necessity  for  determining  whether  or  not  such  charges  have  been 
properly  classified. 

Fourth,  at  the  instance  of  someone  within  the  organisation  to 
prove  or  disprove  some  contention  on  the  part  of  someone  zvithout. 

These  cases  usually  take  the  form  of  some  accusation  against 
the  management  in  connection  with  the  accounts,  and  an  audit  is 
made  at  the  instance  of  the  management  in  order  to  refute  the 
accusation.  Stockholders  sometimes  accuse  the  management  of 
creating  superfluous  reserves,  or  making  excessive  appropriations, 
or  needless  expense  in  order  to  reduce  the  profits  and  consequently 
keep  down  the  dividends.  Charitable  agencies  have  at  times  been 
accused  of  spending  more  of  the  funds  contributed,  for  salaries 
of  the  administrative  officers  than  in  carrying  out  directly  the  pur- 
poses and  objects  of  the  association  or  society.  In  these  cases 
where  the  officers  feel  aggrieved  at  the  unjust  accusation  they  may 
cause  an  audit  to  be  made  for  the  purpose  of  setting  at  rest  these 
contentions. 

Fifth,  at  the  instance  of  someone  within  the  organisation  for 
the  purpose  of  influencing  someone  within. 

The  occasions  of  this  character  are  perhaps  not  so  frequent  as 
some  of  the  others,  but  one  case  will  at  least  serve  to  justify  the 
inclusion  of  this  item  in  the  category.  The  cashier  of  a  bank 
in  one  of  the  southern  cities  felt  that  he  was  not  being  fairly 
treated  in  the  matter  of  salary  by  the  officers  of  the  bank.  In  his 
struggle  for  an  increase  in  salary  he  employed  a  firm  of  certified 
public  accountants  to  make  an  audit  of  the  accounts  of  the  bank 
at  his  expense.  The  audit  and  subsequent  report  in  this  case  was 
used  by  someone  within  the  organization  for  the  purpose  of  at- 
tempting to  influence  someone  within  the  organization. 

Sixth,  at  the  instance  of  someone  within  the  organization  to 
influence  someone  without. 

Striking  examples  of  this  class  are  cases  in  which  an  attempt 
is  made  to  sell  stock  or  bonds  or  a  proprietary  interest  in  a  business 
concern.  Banks  also  are  frequently  influenced  in  the  direction  of 
making  loans  or  discounting  notes  by  the  financial  condition  or 
result  of  operations  of  an  applicant,  and  they  are  more  apt  to  be 
influenced  when  the  results  are  certified  after  an  audit.  An  en- 
terprising realty  company  not  only  had  the  accounts  of  its  own 
and  the  sixteen  subsidiary  companies  audited  and  the  auditor's 
certificate  appended  to  the  published  statements  thereof,  but  had 

9 


PRINCIPLES  OF   AUDITING 

the  auditor  instruct  the  salesmen  as  to  the  interpretation  of  the 
financial  statements  and  the  effect  of  the  auditor's  certificate  on  the 

situation. 

Charitable  institutions  especially  are  considered  to  derive  bene- 
fit from  having  their  accounts  audited  and  appending  the  auditor's 
certificate  to  the  financial  statements  which  appear  in  their  printed 
reports.  Contributors  past  and  prospective  are  thought  to  be  in- 
fluenced through  the  knowledge  that  the  funds  of  the  societies  in 
question  have  been  properly  used  and  accurately  accounted  for. 
It  is  unquestionably  true  that  publicity,  especially  when  the  in- 
formation is  supported  by  independent  and  competent  opinion, 
stimulates  interest  and  support.  It  may  be  interesting  to  know 
that  there  are  some  thirty-six  hundred  charitable  agencies  in  the 
metropolitan  district,  that  is  to  say,  charity  organizations  which 
are  supported  either  wholly  or  in  part  by  public  contributions. 
This  work  is  more  or  less  correlated  by  a  central  association 
known  as  the  Charity  Organization  Society.  The  Charity  Or- 
ganization Society  has  a  bureau  known  as  the  bureau  of  advice 
and  information  which  serves  these  agencies  somewhat  in  the 
capacity  in  which  the  Dun  and  Bradstreet  mercantile  agencies 
serve  the  mercantile  world,  in  that  it  classifies,  rates  and  lists 
these  different  agencies.  If  a  man  like  Mr.  Rockefeller,  for  ex- 
ample, is  approached  by  someone  for  a  contribution  to  some  charity 
and  he  does  not  know  the  person  or  the  society,  or  whether  or 
not  it  is  worthy,  he  may  refer  to  the  book  published  by  the 
Charity  Organization  Society  in  which  these  agencies  are  rated, 
and  perhaps  decide  whether  or  not  to  contribute.  The  bureau 
finds  it  difficult  to  rate  these  agencies  properly  because  many  of 
them  do  not  have  proper  and  adequate  systems  of  accounting,  and 
do  not  make  comprehensive  reports.  It  is  now  a  part  of  the 
bureau's  program  to  insist  that  the  accounts  be  audited  before 
agencies  are  listed. 

Under  the  second  division  of  the  category  come  the  occasions 
which  arise  at  the  instance  of  someone  without  the  organization. 
These,  as  before,  may  be  taken  up  as  listed. 

First,  at  the  instance  of  someone  without  the  organisation  to 
satisfy  someone  without. 

Subscribers  to  capital  stock  may  cause  an  audit  of  certain 
accounts  to  be  made  in  order  to  satisfy  themselves  as  to  the  disposi- 
tion of  funds  which  they  have  paid  into  the  corporation.  Stock- 

10 


THE    OCCASIONS    FOR    AUDITING 

holders  may  likewise  have  made  at  their  own  expense,  audits  in 
order  that  they  may  judge  of  the  efficiency  of  the  management. 
Directors  sometimes  want  information  as  to  the  acts  of  receivers 
or  trustees.  Here,  of  course,  the  normal  situation  is  reversed. 
Ordinarily,  the  director  is  an  insider.  There  may  come  a  time, 
however,  when  the  company  goes  into  the  hands  of  the  receiver, 
and  subsequently  the  trustee  carries  on  the  business.  Under  such 
circumstances  both  the  receiver  and  trustee  are  representatives  of 
the  court  in  behalf  of  the  creditors,  while  the  directors  become 
outsiders.  Other  illustrations  of  the  above  class  are  beneficiaries 
under  sinking  funds,  who  at  times  have  audits  made.  There  might 
also  be  included  fidelity  companies  where  bonded  employes  are 
suspected  of  having  defaulted.  It  should  not  be  overlooked  in- 
cidentally that  the  employer  companies  frequently  have  the  ac- 
counts of  bonded  employes  audited  in  order  to  avail  themselves 
of  the  lower  premium  rate  which  the  bonding  companies  offer  in 
such  cases. 

Second,  at  the  instance  of  someone  without  the  organisation  to 
prove  or  disprove  the  contention  of  someone  without. 

Minority  and  other  stockholders  sometimes  raise  contentions 
concerning  the  management  of  the  directors  or  officers  and  cause 
an  audit  to  be  made.  Not  long  ago  a  holder  of  sixteen  hundred 
shares  of  stock  in  the  Brooklyn  Union  Gas  Company  headed  a 
movement  of  minority  stockholders  who  employed  accountants  to 
go  over  the  books  for  the  purpose  of  proving  that  certain  divi- 
dends had  not  been  paid  out  of  the  profits. 

Bondholders  may  take  similar  steps  in  cases  where  interest 
on  bonds  has  not  been  paid  and  where  it  is  contended  that  if 
certain  charges  had  not  been  excessive  there  would  have  been 
sufficient  profits  to  have  met  the  bond  interest. 

Claimants  of  royalties  frequently  make  the  contention  that 
they  are  not  receiving  as  much  as  they  should  and  an  auditor  is 
engaged  by  such  claimants  to  determine  whether  or  not  the  con- 
tention is  correct.  An  advertising  man  who  recently  closed  a 
contract  whereby  he  was  to  receive  a  certain  percentage  of  the 
sales  as  his  compensation  for  doing  the  advertising  work,  had 
written  into  the  contract  the  provision  that  the  accounts  should  be 
audited.  This  was  taking  the  proverbial  "stitch  in  time." 

Third,  at  the  instance  of  someone  without  the  organisation  to 
influence  someone  without. 

ii 


PRINCIPLES    OF    AUDITING 

Bond  houses  bringing  out  or  selling  securities  of  certain  com- 
panies serve  to  illustrate  this  class.  A  prominent  bond  invest- 
ment house  recently  had  a  combination  investment  consisting  of 
five  $1,000  bonds  presenting  diversity,  safety  of  principal,  market- 
ability, liberal  income  and  opportunity  of  appreciation.  It  is  not 
probable  that  the  house  in  question  would  make  a  statement  such 
as  the  above  without  having  satisfied  itself  through  audits  as  to 
the  financial  status  of  the  companies  whose  bonds  were  offered. 
Circulars  offering  investments  are  now  rare  which  do  not  contain 
a  statement  to  the  effect  that  the  books  have  been  audited  by  some 
well  known  firm  of  certified  public  accountants.  Included  in  this 
group  should  be  underwriters,  who,  preliminary  to  the  consolida- 
tion of  a  number  of  companies,  have  the  accounts  of  the  com- 
panies in  question  audited.  These  like  the  above,  it  will  be  seen, 
are  usually  occasioned  by  the  desire  on  the  part  of  someone  out- 
side the  organization  to  influence  someone  also  outside. 

It  may  perhaps  be  said  that  the  object  of  the  discussion  just 
concluded  is  that  proper  cognizance  may  be  taken  of  the  party  or 
parties  to  whom  the  auditor  is  to  report.  It  is  important  at  all 
times  that  the  auditor  should  determine  the  party  for  whom  the 
work  is  being  done  in  order  that  he  may  know  to  whom  his  report 
is  to  be  addressed  and  delivered.  Considerable  embarrassment 
may  follow  the  delivery  of  a  report  to  the  wrong  person.  In 
some  cases  clients  are  known  to  have  refused  payment  of  the  fee 
because  the  report  was  not  delivered  to  the  proper  person. 


12 


CHAPTER  IV 

AUDITS  DIFFERENTIATED  FROM  EXAMINATIONS  AND 
INVESTIGATIONS 

Auditing  connotes  reviewing  accounting  work.  Reviewing  ac- 
counting work  means  reviewing  the  records  which  appear  on  the 
books,  extending  from  the  books  of  original  entry  to  the  general 
books  as  well  as  the  financial  statements  which  are  prepared 
therefrom.  If  one  were  to  trace  all  the  financial  transactions  of 
a  business  it  would  be  necessary  to  begin  with  the  books  of 
original  entry  where  all  the  details  are  shown;  to  follow  these 
transactions  through  the  intervening  stage  of  classification,  com- 
bination and  grouping  into  the  general  ledger  and  from  the  gen- 
eral ledger  through  the  trial  balance  into  the  balance  sheet  and 
statement  of  income  and  profit  and  loss.  If  one  were  to  make  a 
complete  audit  it  would  be  necessary  to  review  in  its  entirety  the 
work  incident  to  the  financial  transactions  just  mentioned.  Un- 
fortunately the  occasions  are  rare  in  which  it  is  possible  to  indulge 
one's  love  of  thoroughness  to  this  extent.  Great  is  the  satisfac- 
tion where  the  operations  of  the  organization  under  audit  are  so 
small  in  volume  as  to  make  it  possible  to  check  every  figure.  In 
auditing  the  accounts  of  a  large  department  store  where  thou- 
sands upon  thousands  of  sales  are  made  in  the  course  of  a  year, 
a  corresponding  number  of  sales  slips  would  doubtless  be  en- 
countered. To  be  absolutely  sure  that  all  sales  had  been  accounted 
for,  it  would  be  necessary  to  examine  and  verify  every  one  of  the 
sales  slips.  After  verifying  the  amounts  it  would  be  necessary  to 
add  them  up  and  trace  the  totals  into  the  general  books.  If  the 
work  concerning  all  the  various  phases  of  the  business  were  car- 
ried out  in  such  detail,  the  audit  would  be  a  complete  one.  Obvi- 
ously, however,  it  would  be  quite  out  of  the  question,  except  in 
rare  instances,  for  the  professional  auditor  to  attain  such  degree 
of  thoroughness. 

Audits  may  be  complete  or  partial.  The  ideal  audit  is  a  com- 
plete one.  While  perhaps  one  of  the  most  unsatisfactory  things 
about  auditing  is  the  fact  that  oftener  than  otherwise  the  audit 
must  be  a  partial  one,  professional  practice  has  dictated  that 
the  client  may  not  as  a  rule  expect  more  than  a  partial  audit.  It 

13 


PRINCIPLES  OF   AUDITING 

is  doubtful  if  most  clients  understand  what  is  really  meant  by 
testing  and  it  is  doubtful  if  many  clients  are  consulted  as  to 
whether  or  not  testing  shall  be  done.  It  is  probably  not  an  ex- 
travagant statement  to  say  that  testing  is  a  device  of  which  the 
auditor  avails  himself  in  order  to  satisfy  himself  as  best  he  may 
where  for  one  reason  or  another  thoroughness  and  the  amount  of 
time  which  necessarily  accompanies  it  are  out  of  the  question.  As 
an  illustration  of  testing,  sales  invoices  might  be  taken.  Picking 
out  from  four  to  six  months,  say  January,  June,  July,  September, 
November  and  December,  the  sales  invoices  would  be  checked 
against  the  sales  records  unless  duplicate  invoices  were  used  for 
same ;  the  footings  of  the  sales  records  for  the  respective  months 
should  be  proved  and  the  monthly  totals  followed  forward  into 
the  general  ledger.  The  individual  invoices  should  be  followed 
into  the  customers'  accounts.  Such  procedure  is  known  as  testing, 
and  testing  usually  accompanies  a  partial  audit.  Testing  should 
be  accompanied  by  judgment. 

An  examination  differs  from  an  audit  in  that  it  attempts  to 
verify  results  rather  than  the  processes  whereby  the  results  were 
obtained.  Results  are  usually  expressed  in  a  financial  statement 
called  the  balance  sheet.  An  examination,  therefore,  practically 
consists  in  verifying  the  assets  and  liabilities  including  the  ac- 
countabilities. An  examination  is  frequently  referred  to  as  a 
balance  sheet  audit. 

An  investigation  is  a  matter  which  refers  to  a  transaction, 
series  of  transactions  or  phase  of  a  business,  and  differs  from  an 
examination  in  that  it  attempts  to  ascertain  but  not  prove  the 
facts  concerning  a  transaction  or  phase  of  the  business  from  its 
inception  to  its  termination.  In  an  investigation  it  might  be  im- 
portant to  know  what  details  constituted  a  certain  transaction  or 
series  of  transactions  as  a  matter  of  information,  but  the  details 
would  probably  be  accepted  without  attempting  to  prove  them.  It 
is  a  difficult  matter  to  state  a  definite  rule  for  identifying  or  dis- 
tinguishing investigations.  Contrary  to  the  impression  just  given, 
some  investigations  lead  to  litigation  wherein  it  is  necessary  to 
prove  in  court  all  the  details  involved  in  the  transaction.  As  gen- 
erally understood,  however,  investigations  frequently  refer  to  the 
determination  of  the  earnings  of  an  organization  extending  over  a 

•iod  of  years  or  a  determination  of  the  cost  of  production  in 
which  cases  the  records  on  the  books  are  accepted  as  being  true 

14 


and  correct,  no  attempt  being  made  to  prove  the  details  which 
support  the  conclusion. 

While  it  may  not  be  clear  from  the  preceding  discussion  as  to 
the  exact  difference  between  an  audit  and  an  examination  or  an 
examination  and  an  investigation,  there  is  one  thing  about  which 
the  student  or  the  young  man  starting  work  in  the  profession 
should  bear  in  mind,  namely,  that  all  engagements  are  not  audits. 
It  is  perhaps  of  greater  importance  to  appreciate  this  fact  and  to 
know  that  a  difference  does  exist  among  the  various  classes  of 
engagements  mentioned  rather  than  not  to  know  exactly  what 
these  differences  are.  One  of  the  most  pathetic  exhibitions  a 
young  man  may  be  guilty  of  is  to  begin  a  thorough  audit  of  a 
set  of  books  when  it  was  intended  by  the  client  that  he  should 
investigate  only  a  certain  matter. 


THE  ENGAGEMENT 

The  discussion  which  follows  will  deal  principally  with  the 
subject  of  auditing  from  the  professional  point  of  view.  It  may 
be  desirable  at  times  to  mention  the  work  of  the  non-professional 
auditor,  but  it  should  be  borne  in  mind  that  the  subject  is  being 
generally  discussed  from  the  other  point  of  view. 

There  are  certain  preliminaries  preceding  the  beginning  of  an 
audit  which  seem  to  require  some  attention  before  going  ahead. 
Some  men  have  jobs,  some  men  have  positions;  some  concerns 
speak  about  making  sales,  other  concerns  talk  about  taking  con- 
tracts, while  others  will  be  heard  talking  about  getting  jobs.  The 
accountant  refers  to  his  work  as  the  taking  of  an  engagement. 
Engagement  is  the  technical  accounting  term  used  to  denote  that 
arrangement  or  agreement  which  the  accountant  makes  whereby 
he  takes  up  certain  work  for  a  client.  The  word  client  as  used 
here  is  also  a  technical  accounting  term  indicating  the  party  for 
whom  the  work  is  done.  It  is  analogous  to  the  word  customer 
as  used  in  trading.  In  business  it  is  considered  important  that 
when  two  parties  agree  on  a  certain  thing  and  there  is  a  meeting 
of  the  minds  that  some  expression  of  the  agreement  or  contract, 
as  it  is  now  called,  which  has  resulted  shall  be  recorded.  That 
is,  of  course,  contracts  of  any  importance.  Simple  matters  which 
two  persons  are  able  to  remember  without  any  difficulty  do  not 
need  to  be  expressed  in  writing.  When  a  contract  becomes  so 
complicated  that  it  is  not  possible  for  the  parties  thereto  to  re- 
member the  facts  concerning  it,  it  is  usual  to  express  those  facts 
in  writing. 

Usually  in  taking  engagements  there  are  a  number  of  stipula- 
tions to  be  made ;  certain  things  to  be  done ;  certain  information 
necessary  in  order  that  the  work  may  be  carried  out  intelligently  by 
everyone  concerned,  and  for  that  reason  an  engagement  blank  is 
prepared.  The  specimen  engagement  blank  which  follows  ap- 
parently needs  no  description  since  it  is  self-explanatory. 

It  does  not  always  follow  that  the  work  of  an  engagement  will 
be  done  in  the  office  of  the  client.  The  treasurer  of  some  organi- 
zation in  Wall  Street  may  employ  an  accountant  to  audit  the  ac- 

16 


THE  ENGAGEMENT 

Counts  of  an  institution  in  Forty-second  Street.  An  accountant 
may  be  employed  at  times  by  one  party  to  audit  the  accounts  of  a 
second  party,  with  the  permission,  of  course,  of  the  second  party, 
so  that  it  is  important  to  have  on  the  engagement  blank  as  much 
information  as  possible  concerning  the  engagement.  An  accurate 


O 


JONES    &     PARKER  MEMO.  OF  ENGAGEMENT  No.    15Q 

ASSIGNED  TO 
Office.         February  5, '1915. 


»NT» 

ASSIGNED  TO 


1.  Client,     warburt.cn  Desk  Company, 

2.  Address.     265  Broadway,  Hew  York. 

3.  Conference.     John  Wood,  President. 

4.  Letter,     dated  February  1,  1915. 

5.  Telephone.  Barclay    1894 

^~^\  &  Report  lo  be  addressed  to.  President. 

7  Account  10  be  charged  in  Ledger,        WarbUTtOn  Desk  Company. 

&  Examination  to  be  made  of,          same. 

^•^  ft  Where  located.          as    above . 

to.  Nature oi business.     Manufacturer  of  defies. 

II.  Nature  of  work.  Audit  for  the  year  ended  December  31, 


12.  When  to  be  commenced,       February   12,    1915. 

13.  Probable  time  required,       four   Weeks  . 

14.  Accountants  required.       one    Senior. 

15.  Rates,          usual. 

i&  Remarks.  Report  required  not  later  than  March  15,  1915. 


(Noted:    Foruseof  New  Yorkofficeonly) 


Specimen  Engagement  Blank 

description  of  the  work  to  be  done  is  very  important  since  there 
are  a  number  of  people  interested  in  the  information.  The  man 
who  manages  the  staff  wants  to  know  when  the  work  is  to  be 
commenced  so  that  he  may  have  the  necessary  accountants  of  the 

17 


PRINCIPLES  OF  AUDITING 

right  grade  ready  at  the  proper  time.  He  needs  to  know  the  prob- 
able length  of  time  required  so  that  he  may  know  when  such  men 
will  be  available  for  other  work.  It  is  not  always  possible  to  say 
with  exactness  how  long  an  engagement  will  take,  but  it  is  pos- 
sible by  using  a  small  amount  of  time  for  the  purpose  of  esti- 
mating, to  determine  with  a  fair  degree  of  accuracy,  the  length  of 
time  required.  Take,  for  example,  the  vouching  of  cash  disburse- 
ments and  the  footing  of  the  cash  book.  One  may  determine  very 
easily  the  length  of  time  required  to  check  a  page  of  entries  con- 
taining forty  or  fifty  items  and  also  how  long  it  takes  to  foot  a 
column  of  figures  that  long.  With  this  information  it  is  an  easy 
matter  to  look  through  the  book  and  find  how  many  pages  of  cash 
disbursements  there  are.  By  multiplying  the  time  required  for 
one  page  by  the  number  of  pages,  the  total  time  required  for 
vouching  and  footing  the  disbursements  is  ascertained.  By  apply- 
ing this  test  to  the  various  units  of  work  and  putting  together 
the  time  of  the  various  units  it  is  possible  to  determine  approxi- 
mately the  length  of  time  required  for  the  engagement.  A  liberal 
percentage  must  also  be  added  of  course  to  allow  for  failure  of 
the  man  performing  the  work  to  live  up  to  the  schedule,  and  to 
a  certain  extent,  to  cover  unforeseen  circumstances.  A  hasty  ex- 
amination of  this  kind  may  not  disclose  the  fact  that  all  vouchers 
and  documents  are  not  of  the  same  type  and  that  numerous 
vouchers,  for  example,  are  supported  by  many  sub-vouchers, 
which  fact  was  overlooked  in  making  the  estimate.  Neverthe- 
less, a  rough  idea  of  how  long  a  man  will  be  engaged  is  better 
than  no  idea  at  all. 

The  probable  length  of  time  required  on  an  engagement  is  of 
interest  not  only  to  the  staff  manager  in  order  that  he  may 
know  when  the  man  will  be  available,  but  to  the  man  who  makes 
a  flat  or  contract  price  for  an  engagement.  Incidentally,  it  is 
not  a  good  plan  to  take  contract  engagements.  The  element  of 
risk  is  too  great  on  all  sides.  The  accountant  is  liable  to  under- 
estimate the  length  of  time  required  to  do  the  work  and  con- 
sequently one  of  three  things  may  happen.  Either  the  accountant 
will  lose  money  on  the  engagement  or  he  will  make  money  at  the 
expense  of  his  staff  by  working  the  men  overtime,  or  the  quality 
of  the  work  will  suffer.  While  theoretically,  contract  engagements 
are  wrong,  as  a  matter  of  practice  they  are  common. 

If  an  accountant  is  working  for  himself  the  engagement  blank 

18 


THE  ENGAGEMENT 

is  handy  as  a  memorandum  of  conditions.  If  he  is  working  for 
some  one  else  it  is  handy  for  purposes  of  information.  An  ideal 
engagement  blank  is  one  that  will  convey  to  any  one  who  has 
occasion  to  use  it,  all  the  information  pertaining  to  the  engage- 
ment. The  number  of  copies  to  be  made  may  differ  in  different 
offices.  The  accountant  working  for  himself  needs  but  one  or  at 
the  most  two.  In  a  large  office  it  is  customary  to  make  four 
copies;  the  original  and  three  carbons.  One  goes  to  the  staff 
manager  in  order  that  he  may  know  what  to  do  and  when  to  do 
it;  one  copy  goes  to  the  financial  department  in  order  that  the 
account  with  the  client  may  be  opened  and  provision  made  for  the 
charges  as  they  come  through ;  a  third  copy  goes  to  the  file  room 
in  order  that  the  man  in  charge  of  the  file  room  may  be  on  the 
lookout  for  working  papers  and  reports  from  the  respective  en- 
gagements and  in  order  that  he  may  know  to  whom  to  send  the 
report  when  it  is  ready  to  be  delivered.  The  accountant  who 
takes  up  the  engagement  receives  the  fourth  copy  and  requires 
the  information  in  order  that  he  may  proceed  with  the  work 
intelligently. 

Most  engagements  are  carried  out  in  the  offices  of  clients.  It 
would  perhaps  be  more  exact  to  say  that  the  work  on  most  en- 
gagements is  carried  on  outside  of  the  office  of  the  accountant. 
There  will  occasionally  arise,  however,  engagements  where  the 
books  are  small  and  the  vouchers  are  few  in  number  and  all  books 
and  papers  may  be  taken  to  the  office  of  the  accountant  and  the 
work  done  there.  In  the  majority  of  cases  this  will  not  be  so. 

It  has  seemed  to  the  author  that  students  might  get  a  better 
grasp  of  the  subject  if  each  student  as  he  pursues  the  reading 
of  this  text  imagines  that  he  is  going  out  on  a  small  engagement 
where  he  would  do  personally  all  the  work.  Such,  as  a  matter  of 
fact,  is  the  best  kind  of  experience  for  the  young  man.  Out  of 
such  an  engagement  where  there  is  an  opportunity  not  only  to  see 
but  to  do  the  work  in  its  entirety,  most  benefit  is  to  be  derived. 
Young  men  about  to  enter  the  profession  frequently  ask  the  ques- 
tion as  to  whether  it  is  better  to  go  with  a  large  or  with  a  small 
concern.  It  seems  to  be  difficult  to  decide  since  each  has  its 
advantages  and  disadvantages.  In  one  case  the  young  man  comes 
in  contact  with  small  engagements  where  he  learns  all  there  is 
to  be  learned  about  them.  As  a  rule,  however,  he  sees  no  large 
engagements.  On  the  other  hand,  where  he  is  employed  by  a 

19 


PRINCIPLES  OF   AUDITING 

firm  of  accountants  which  has  large  engagements  he  is  apt  for 
a  good  while  to  do  nothing  but  detail  work  and  see  only  a  small 
part  of  the  large  engagements.  While  an  ideal  concern  with 
which  to  serve  an  apprenticeship  is  one  whose  work  is  sufficiently 
broad  in  its  scope  to  offer  a  variety  of  both  small  and  large  en- 
gagements, there  is  one  thing  to  be  said  in  favor  of  the  latter. 
If  the  apprentice  keeps  his  eyes  and  ears  open  and  takes  advantage 
of  all  his  opportunities,  what  he  learns  is  how  to  run  a  large  en- 
gagement. This  may  be  advantageous  to  him  if  he  ever  starts  in 
business  for  himself  and  is  fortunate  enough  to  obtain  a  large 
engagement.  Being  familiar  with  the  large  engagement  he  has 
no  hesitancy  in  accepting  it,  as  he  is  enabled  to  carry  on  the  work 
without  fear  of  failure. 


CHAPTER  VI 

WHAT  TO  Do  BEFORE  BEGINNING  AN  AUDIT 

The  practical  hints  which  follow  may  seem  to  some  too  trivial 
to  warrant  mention.  They  are  admittedly  small  matters.  Just 
these  little  things,  however,  sometimes  make  the  difference  be- 
tween success  and  failure,  in  so  far  as  the  novice  is  concerned.  The 
young  man  starting  in  the  profession  has  a  great  many  persons 
to  satisfy.  There  is  not  only  the  staff  manager  but  the  members 
of  the  office  force  with  whom  he  comes  in  contact,  as  well  as 
the  senior  accountant  who  has  charge  of  the  engagement.  There 
are,  in  addition,  the  employes  of  the  client  and  perhaps  the 
client  himself  with  whom  he  comes  in  contact  on  the  engage- 
ment. To  have  his  work  at  all  times  beyond  reproach  as  he 
comes  in  contact  with  these  various  individuals,  requires  constant 
vigilance.  Attention  to  the  small  details  undoubtedly  goes  a  long 
way  toward  giving  him  a  satisfactory  status. 

The  first  instructions  to  be  given  to  an  accountant  going  out 
on  a  small  engagement  might  be,  "get  your  engagement  blank 
and  your  letter  of  introduction."  The  engagement  blank  has 
already  been  described.  The  letter  of  introduction  might  read  as 
follows : 

JONES   AND   PARKER, 

Certified  Public  Accountants, 

32  WAVERLY  PLACE, 

NEW  YORK  CITY. 

February  12,  1915. 
MR.  J.  G.  SHERMAN,  Treasurer, 
Warburton  Desk  Company, 
265  Broadway, 
New  York. 

Dear  Sir: 

This  will  introduce  our  representative,  Mr.  Arthur  Read,  who  is 
calling  on  you  for  the  purpose  of  taking  up  the  work  of  auditing  the 
accounts  of  the  Warburton  Desk  Company. 

Yours  very  truly, 

(Signed)  JONES  &  PARKER, 

Certified  Public  Accountants. 
21 


PRINCIPLES  OF   AUDITING 

It  is  not  possible  in  these  days  and  especially  in  the  large  cities 
to  walk  into  an  office  and  begin  an  examination  of  accounts  which 
are  frequently  of  a  private  and  confidential  nature  without  creden- 
tials of  some  kind.  The  nature  of  the  accountant's  work  and  the 
liberties  extended  to  him  are  such  as  to  require  that  he  shall  be 
properly  introduced  and  accredited. 

Among  the  other  things  with  which  an  accountant  needs  to 
provide  himself  before  leaving  the  office,  especially  if  he  is  going 
out  of  town,  are  time  and  expense  reports,  expense  funds,  railroad 
and  Pullman  tickets.  It  has  been  said  of  the  professional  ac- 
countant that  one  of  his  compensations  is  that  he  is  permitted  to 
travel  like  a  gentleman. 

Specimen  time  and  expense  reports  follow ; 


WHAT    TO    DO    BEFORE    BEGINNING    AN    AUDIT 


i 

1  H 

s  a  >-  " 

0    "    E     £ 

s  2  2  g  r 

t   5   s   £   S 

Inn 

o 

o 


a 

4 


a 
u 
* 

DC 

£ 


K 


1 


• 


It}'- 

I':?* 

ilMf! 


Accountant's  Time  Report 


PRINCIPLES  OF   AUDITING 


Tar 


rr 


sT 


/ 


Reverse  Side  of  Time  Report 


WHAT    TO   DO    BEFORE    BEGINNING    AN    AUDIT 


1 

i 

1 

in 

ii!| 
•1 

ijj{ 

retain 

JONES   &    PARKER 

MONTANT'S  EXPENSE  REPORT 

•MM 
mm 

MM 

COMTIH 
LfOMI 

M  C  OH  TIOL  
I"   LEMEI_ 

32   WAVERLY  PLACE                           AC 
NEW  YORK 

•• 

,££-, 

«. 

UMOTTMI* 

llflll 

1 

tjr.v« 

•!S!r^.. 

i^V.'.'.1., 

Gtn«fil  fniill 

/?- 

^^_^^< 

M 

s? 

' 

V 

£j! 

fc 

j& 

/A 

^^^r^ 

(9? 

^c^_^a_^l^- 

?T7 

~^^^ 

sft 

7n 

/>? 

Ifi 

to 

y 

/ 

77 

...t 

DEBIT* 

D.X 

CRCOITS 

tilnoi  taN.lt.  (Mo  lot  fwl) 

j 

X 

B.li~c.  <M  m  (Ittm  Ilil  rtport) 

MaMttm 

' 

Diibumd  u  i»on 

/ 

7>- 

. 

TmtlmWU 

. 

Cuh  mmM 

•^M  *»  •«  (H  ma  mtill 
T.W 

Bll.  <»  N.  t  t.  (!•  Mil  ItHrt) 

£, 

-^7 

<5 

>f 

MM 

J 

>^* 

*OVIO 

SlttNATUKI 

^Z^^^L^U  ^Cia^f-^ 

•UXKVIMM 

Accountant's  Expense  Report 

The  accountant  should  always  provide  himself  with  analysis 
paper,  twelve  or  fourteen  columns,  preferably  fourteen,  since  the 
latter  is  better  adapted  to  the  use  of  the  working  sheet.  There 
should  also  be  included  in  the  equipment,  journal  paper,  bank 
certificates  in  blank,  scratch  paper,  $2  black  pencils,,  blue  and  red 
pencils,  a  rubber  eraser  and  a  small  ruler  not  over  twelve  inches 
long.  For  the  benefit  of  the  uninitiated  there  follows  a  reproduc- 
tion of  analysis  paper. 

25 


PRINCIPLES  OF  AUDITING 


26 


WHAT    TO    DO    BEFORE    BEGINNING    AN    AUDIT 

The  accountant's  outfit  is  not  complete  without  a  memoran- 
dum book  or  diary.  In  it  he  should  note  daily  the  engagement 
on  which  he  is  working,  the  hours  during  which  he  has  worked 
and  the  particulars  concerning  the  work  on  which  he  has  been 
engaged.  For  example,  "October  15,  Warburton  Desk  Company 
— 9  to  12;  1  to  5,  counting  cash  and  reconciling  bank  account." 
This  information  will  be  required  when  the  accountant  comes 
to  make  up  his  time  report.  He  should  also  note  in  this  book 
the  details  of  his  expenses  so  that  he  may  supply  these  details 
when  making  up  his  expense  account. 

It  is  well  to  preserve  these  diaries  from  year  to  year,  since 
they  play  an  important  part  at  times  in  case  he  is  called  upon 
to  testify  in  court,  and  requires  something  to  refresh  his  memory 
as  to  precisely  what  he  was  doing  on  a  certain  date  and  at  a 
certain  time.  The  author  had  occasion  during  the  year  1914  to 
give  testimony  concerning  work  which  he  did  during  the  year 
1907.  Two  parties  to  a  series  of  joint  ventures  which  extended 
over  a  period  of  ten  or  twelve  years  became  involved  in  litiga- 
tion. One  party  disclaimed  all  knowledge  of  the  conditions  of 
the  books  and  financial  statements  and  pleaded  ignorance  in 
these  matters.  The  author  was  able,  through  reference  to  his 
old  diaries,  to  give  dates  and  hours  at  which  he  discussed  in 
detail  the  conditions  of  the  books  and  the  statements  with  this 
particular  .party.  It  is  needless  to  say  that  this  evidence  was 
damaging  to  the  party  just  mentioned.  The  judge  later  referred 
to  the  testimony  as  being  "precise  and  convincing."  This  inci- 
dent is  mentioned  simply  to  illustrate  the  manner  in  which  an 
accurate  diary  may  be  of  considerable  value  to  the  accountant 
in  enabling  him  to  appear  favorably  if  called  upon  to  give 
testimony. 

The  supplies  previously  mentioned  should  be  gathered  and 
put  into  an  envelope  or  bag.  A  working  bag  with  the  name- 
plate  on  the  outside  is  of  course  desirable.  A  heavy  paper  or 
linen  envelope  will,  however,  serve  the  same  purpose  if  the  sup- 
plies are  not  too  numerous  or  extensive  in  quantity.  At  any 
rate,  the  accountant's  name  and  address  or  the  name  and  address 
of  the  firm  for  which  he  is  working,  should  be  put  on  the  out- 
side of  the  envelope.  This  is  in  order  that  the  envelope  may  be 
restored  to  its  owner  in  case  of  loss,  which  is  of  all  the  more 
importance  in  case  the  envelope  happens  to  contain  old  working 

27 


PRINCIPLES  OF   AUDITING 

papers  which  may  be  private  in  their  nature.  Accountants  have 
been  known  to  become  so  engrossed  in  thinking  about  their  work 
while  traveling  on  cars  and  trains  as  to  leave  bags  or  envelopes 
behind  upon  quitting  the  conveyance. 

Upon  reaching  the  office  of  the  client  the  accountant  should 
conduct  himself  with  humility  and  be  polite.  Politeness  carries  a 
great  deal  of  weight,  and  humility  makes  a  good  impression.  To 
walk  into  the  office  of  a  client  with  one's  hat  on  and  with  no 
regard  for  the  people  in  the  office,  tends  to  create  a  prejudice  in 
the  very  beginning.  It  is  perhaps  almost  unnecessary  to  say 
"take  off  your  hat  and  be  polite  and  friendly  but  not  familiar." 
Due  regard  for  the  client  and  his  employes  will  frequently  open 
the  way  for  relations  which  will  be  pleasant,  and  in  so  far  as  they 
concern  the  success  of  the  accountant  on  that  particular  engage- 
ment, profitable. 

No  time  will  be  wasted  which  is  spent  in  getting  the  em- 
ployes with  whom  the  accountant  comes  in  contact  into  the 
proper  frame  of  mind.  The  man  or  woman  whose  work  is  to 
be  reviewed  will  react  favorably  if  given  credit  for  knowing 
more  about  the  details  of  the  work  than  the  accountant.  A 
man  who  has  been  keeping  a  set  of  books  for  some  time,  ob- 
viously knows  more  about  them  than  the  stranger,  no  matter 
how  expert  or  learned  in  his  profession  he  may  be.  The  book- 
keeper will  appreciate  being  permitted  to  feel  that  this  is  so  and 
will  resent  being  told  that  he  does  not  know  his  business,  that 
the  system  is  poor,  or  that  his  methods  are  old-fashioned.  These 
things  may  all  be  so  but  no  good  comes  of  impressing  them  on 
the  person  affected.  Because  of  the  fact  that  he  is  a  human 
being  to  do  so  will  be  almost  sure  to  make  an  enemy  of  him. 
This,  of  course,  should  not  be  carried  to  the  extent  of  becoming  a 
hypocrite.  One  may  use  tact  and  diplomacy  in  approaching  a 
client  or  his  employes  without  becoming  a  hypocrite. 

Above  all  things  do  not  assume  that  all  men  are  "crooks." 
The  auditor  who  gets  that  point  of  view  has  a  miserable  time. 
A  better  point  of  view  is  that  of  assuming  that  the  auditor  is 
there  for  the  purpose  of  establishing  the  fact  that  everything 
is  right,  and  assuming  that  such  is  the  case,  until  proved  otherwise. 
The  auditor  should  not  make  himself  objectionable  on  an  en- 
gagement by  asking  too  many  questions.  He  should  use  his 
brains,  think  about  things  and  study  them  out  for  himself.  "Keep 

28 


WHAT    TO    DO    BEFORE    BEGINNING    AN    AUDIT 

your  mouth  shut,  your  ears  and  eyes  open"  is  a  good  rule.  Many 
instances  have  come  to  notice  where  accountants  have  made 
themselves  disliked  through  the  habit  of  asking  numerous  and 
unnecessary  questions. 

Ideals  are  excellent,  but  they  should  not  be  allowed  to  pre- 
vail over  common  sense.  They  should  be  tempered  with  judg- 
ment. Procedure  which  might  be  quite  proper  in  general  would 
perhaps  need  to  be  changed  in  a  case,  for  instance,  where  the 
stock  of  a  certain  corporation  is  all  owned  by  one  man,  the  re- 
port goes  to  one  man,  affects  no  one  in  the  organization  but 
himself  and  is  used  for  no  outside  purpose.  Certain  opinions 
of  such  a  man  may  not  coincide  precisely  with  those  of  the  ac- 
countant. He  may  wish  his  books  kept  in  a  certain  way.  The 
accountant  need  feel  no  offense  because  this  is  so.  He  may  have 
the  opinion  that  the  ideas  of  the  proprietor  are  wrong  and  that 
his  way  of  doing  things  are  not  the  most  approved,  but  there  is 
no  reason  why  he  should  drop  the  engagement  because  of  this 
fact.  The  position  of  the  proprietor  may  not  be  a  variation  of 
principle  but  represent  rather  a  difference  of  opinion  If  such  a 
man  wishes  the  accountant  to  certify  to  the  effect  that  the 
accounts  are  right  and  properly  kept  and  the  accountant  feels 
that  they  are  not  all  right,  it  is  a  different  matter  entirely.  Ethics 
and  honor  are  two  things  to  be  zealously  guarded. 

Another  important  thing  is  to  find  a  comfortable  place  to 
work.  A  table  or  desk  that  permits  papers  to  be  spread  about 
is  desirable.  The  work  should  be  carried  on  by  daylight  if  pos- 
sible rather  than  by  artificial  light.  The  light  should  come  in 
over  the  left  shoulder  if  such  arrangement  can  be  effected.  The 
auditor  will  as  a  rule  be  more  comfortable  in  a  room  by  himself. 
This,  however,  is  not  always  possible.  He  should  learn  to  work 
if  necessary  in  a  place  where  there  is  nothing  but  noise  and 
confusion.  He  should  school  himself  so  that  if  it  becomes  nec- 
essary, he  may  work  in  a  factory  where  all  the  machinery  is 
running.  He  should  learn  to  pull  himself  into  his  shell  as  it 
were,  and  shut  out  all  the  noise;  to  concentrate  on  the  work 
before  him.  The  old-fashioned  sign,  "Don't  talk  to  the  book- 
keeper," is  a  thing  of  the  past.  If  the  accountant  were  to  dis- 
play a  sign,  "Don't  talk  to  the  accountant,"  he  would  become  the 
laughing  stock  of  those  about  him.  He  is  expected  to  work  if 
necessary  in  a  place  where  there  is  nothing  but  confusion ;  people 

29 


PRINCIPLES  OF   AUDITING 


talking  to  him;  people  bringing  books  to  him  and  taking  books 
away  from  him.  He  may  be  in  the  act  of  footing  a  column  of 
figures  when  someone  comes  to  take  the  book  away.  Conse- 
quently he  must  learn  to  accommodate  himself  to  circumstances. 


How  to  Begin  an  Audit 


CHAPTER    VII 

COUNTING  THE  CASH 

The  preliminaries  over,  attention  should  be  devoted  to  count- 
ing the  cash,  notes  receivable,  and  the  securities.  These  should 
be  counted  at  once  because  of  the  fact  that  they  may  move. 
The  make-up  of  cash  to-day  will  probably  not  be  the  make-up 
of  the  cash  to-morrow.  Securities  on  hand  to-day  may  not  be 
the  same  to-morrow. 

Having  included  in  the  outfit  of  supplies  a  quantity  of  jour- 
nal paper,  a  sheet  or  more  of  same  will  probably  be  found  best 
adapted  to  recording  the  count  of  the  cash.  The  sheet  should 
be  headed  up,  showing  at  the  top  the  name  of  the  client  or 
the  name  of  the  organization  whose  cash  is  being  counted, 
together  with  the  address  of  same,  the  date  and  hour  of  the 
count  and  the  name  of  the  person  who  has  the  custody  of  the 
cash.  It  is  probably  preferable  to  allow  the  person  who  is  in 
charge  of  the  cash  to  handle  same.  There  are  two  reasons 
for  this.  One  is  that  the  auditor  is  not  as  a  rule  skilled  in  the 
handling  of  cash.  A  man  who  is  handling  it  all  the  time  can 
count  it  very  much  faster  and  with  more  accuracy  than  a  man 
who  counts  cash  once  in  a  while.  Such  a  man  is  liable  to  be 
clumsy  and  more  apt  to  make  a  mistake  than  the  other  man. 
The  other  reason  is  that  if  the  auditor  does  not  handle  the 
cash  himself  there  is  no  possibility  of  his  becoming  involved 
in  any  irregularity.  He  may  thus  avoid  becoming  a  victim  of  a 
sharp  trick.  Cashiers  have  been  known  where  irregularities  exist 
to  attempt  to  put  a  part  of  it  at  least  on  the  auditor  who  counted 
the  cash.  If  the  auditor  does  not  touch  the  money  he  will  not 
be  involved  in  any  such  altercation. 

The  cash  should  be  listed  on  a  sheet  of  journal  paper  show- 
ing separately  the  bills  according  to  denominations  as  well  as 
the  total  amount  of  bills ;  the  gold  by  denominations  showing  the 
total  and  the  silver  by  denominations  showing  the  total.  Any 
I.  O.  U.'s,  checks  or  vouchers,  should  be  listed  and  full  particu- 
lars given.  A  check  mark  of  some  kind  should  be  placed  on 
these  papers  individually,  to  indicate  that  they  have  once  been 
seen  and  to  prevent  any  question  from  arising  later  as  to  whether 

33 


PRINCIPLES  OF  AUDITING 

or  not  such  is  the  case.  Here,  again,  the  auditor  may  be  the 
victim  of  sharp  practice  through  papers  being  substituted  after 
the  cash  has  been  counted.  It  is  not  necessary  to  make  an 
elaborate  check  mark  which  will  deface  the  papers  or  annoy 
the  person  who  is  responsible  for  them.  A  small  double  tick 
is  equally  satisfactory  in  every  respect. 

While  on  the  subject  of  checking  it  might  be  desirable  to 
insert  a  word  of  caution  about  marking  up  the  books  and  papers 
of  a  client.  The  auditor  has  no  right  to  deface,  mutilate  or 
destroy  the  records  of  the  client  because  he  has  the  right  to 
examine  them.  A  bookkeeper  or  clerk  who  has  been  neat  and 
careful  in  his  work,  resents  having  its  appearance  spoiled  by 
the  auditor. 

Care  should  be  exercised  in  putting  down  everything  in  the 
way  of  information  connected  with  the  count  of  the  cash.  This 
is  important  because  one  never  knows  under  what  circumstances 
the  information  may  be  needed.  If  it  is  put  down  on  paper  it 
may  be  carried  away  and  will  be  available  in  the  future.  The  ac- 
countant might,  for  example,  count  certain  cash  in  Waco,  Texas, 
on  one  date  and  be  obliged  to  discuss  the  cash  account  a  month 
hence  in  New  York  with  some  officer  of  the  company.  It  would 
be  embarrassing  under  such  circumstances,  not  to  have  all  the 
facts,  and  be  obliged  to  communicate  with  the  office  in  Texas 
concerning  the  matter. 

Having  totaled  up  the  sheet  on  which  the  cash  account  ap- 
pears, the  total  according  to  the  account  should  be  compared  with 
the  balance  in  the  cash  book;  the  debit  and  credit  footings  put 
in  the  cash  book  in  ink  by  the  auditor;  a  line  drawn  above  and 
below  the  respective  footings ;  the  initials  of  the  auditor  with 
the  date  placed  alongside  of  each  footing  and  the  balance  noted 
in  the  explanation  column  on  the  debit  side  of  the  cash  book 
in  ink. 

If  there  is  any  difference  between  the  cash  as  counted  and 
the  balance  called  for  by  the  cash  book,  the  person  handling 
the  cash  should  be  given  an  opportunity  to  explain  it  or  run  it 
down.  The  most  honest  cashier  that  ever  lived  may,  under  the 
strain  of  having  his  cash  counted,  exhibit  signs  of  nervousness. 
He  may  count  two  bills  as  one  as  they  stick  together.  In  list- 
ing some  of  the  papers  he  may  skip  one  or  fail  to  put  it  down. 
If  the  auditor  is  handling  and  listing  the  papers,  he  may  make 

34 


COUNTING   THE    CASH 

some  error.  It  is  not  necessary  to  accuse  a  man  of  being  short 
until  he  has  had  an  opportunity  to  look  over  the  accounts.  It 
is  not  necessary  to  accuse  a  cashier  of  crookedness  if  he  is  out 
of  balance  only  to  a  small  extent,  which  difference  undoubtedly 
signifies  carelessness  rather  than  dishonesty.  If  the  discrepancy 
is  sufficiently  large,  even  though  it  is  straightened  out  by  the 
cashier,  the  fact  should  be  brought  immediately  to  the  attention 
of  the  proper  person.  The  matter  should  not  be  left  for  two 
or  three  weeks  when  it  may  be  made  the  subject  of  argument. 
The  auditor  should  go  immediately  to  the  proper  person,  who 
may  be,  depending  upon  the  circumstances,  the  office  manager, 
the  treasurer,  or  perhaps  the  president  of  the  company,  and 
make  the  facts  known.  The  question  is  sometimes  asked,  "If  a 
cashier  is  short  and  puts  in  the  amount  of  shortage,  should  it 
be  reported?"  The  answer  is  that  it  depends  on  circumstances/ 
It  is  quite  evident  that  a  man  may  be  50  cents,  73  cents,  perhaps 
$2.00  or  even  $5.00  out  of  balance  and  willing  to  put  in  the 
amount  of  the  discrepancy.  Under  such  circumstances  it  is  not 
probable  that  the  matter  would  be  worth  reporting.  Such  a 
condition  will  probably  indicate  carelessness  or  unfortunate  in- 
accuracy and  nothing  more.  If,  however,  that  condition  is  found 
repeatedly  in  counting  the  cash  from  month  to  month,  the  in- 
dications are  that  such  person,  altho  not  dishonest,  is  not  suffi- 
ciently careful  and  accurate  to  be  entrusted  with  the  handling 
of  the  cash.  It  should  be  a  matter  of  pride  on  the  part  of 
cashiers  that  they  balance  to  a  cent.  Constant  shortages  in- 
creasing perhaps  in  amount  may  excite  suspicion  of  dishonesty 
which  is  well  founded.  Tellers  in  banks  are  perhaps  an  excep- 
tion to  the  rule  that  cash  should  balance  to  a  penny.  On  account 
of  the  great  volume  of  business  handled  by  receiving  and  paying 
tellers,  it  is  not  unusual  for  mistakes  to  occur  and  discrepancies 
to  result.  This  is  a  well  recognized  situation  and  is  usually 
allowed  and  provided  for  in  an  "over  and  short"  account.  In 
fact,  in  some  of  the  large  banks  the  clerks  and  tellers  are  not 
held  at  night  for  a  balance  if  the  discrepancy  is  less  than  $50.00. 
All  the  cash  should  be  counted.  It  does  not  matter  if  the 
cashier  insists  that  a  certain  envelope  with  money  in  it  does  not 
belong  in  his  cash,  it  should  be  counted  anyway.  The  amount 
need  not  necessarily  be  included  in  the  regular  count  of  the 
cash,  but  the  amount  involved  should  be  jotted  down  on  a  paper 

35 


PRINCIPLES  OF  AUDITING 

so  that  a  record  will  be  had  of  it  in  case  it  is  needed  later.  It 
is  probably  not  going  too  far  to  say  to  the  novice,  look  through 
all  the  drawers  or  compartments  of  the  cash  box  or  till  and 
see  that  everything  is  presented  for  verification.  It  is  sometimes 
desirable  to  look  through  the  compartments  in  the  safe  where 
cash  is  sometimes  kept  in  order  to  be  sure  that  nothing  escapes 
attention.  Some  authorities  hold  that  small  amounts  of  cash 
need  not  be  counted.  The  author's  feeling  in  the  matter  is  that 
all  cash,  no  matter  how  small  in  amount,  should  be  counted,  if 
for  no  other  reason  than  the  moral  effect  which  the  procedure 
has. 

The  auditor  should  not  accept  without  visual  examination, 
canvas  bags  said  to  contain  silver.  He  should  insist  that  the 
bags  be  opened  so  that  he  may  assure  himself  of  the  contents 
and  proceed  to  have  it  counted  or  count  it  himself.  Where  the 
quantity  is  extensive,  as  in  the  case  of  banks  or  trust  companies, 
it  is  possible  frequently  to  save  considerable  time  by  taking  the 
money  to  some  neighboring  bank  and  have  it  put  through  a 
machine  for  counting  money.  Some  of  these  machines  merely 
count  the  money  while  others  count  it  and  put  it  up  in  pack- 
ages. The  auditor  may  save  the  man  who  follows  him  on  the 
engagement,  considerable  time,  if  after  counting  the  small  change, 
he  puts  it  into  a  bag  and  places  a  seal  with  his  certificate  on 
the  bag.  The  succeeding  auditor  upon  finding  that  the  seals  have 
not  been  broken  will  then  be  relieved  of  the  necessity  of  counting 
the  money  again. 

Gold  may  be  weighed.  While  ordinarily  very  little  gold  is 
encountered  in  making  a  cash  count,  there  will  be  times,  as  in 
the  case  of  banks  where  great  quantities  of  gold  will  be  found. 
If  the  auditor  will  count  a  thousand  dollars  worth  of  gold  and 
weigh  it,  he  will  then  have  a  basis  upon  which  to  calculate  the 
total  amount  of  the  gold  involved.  This  method  is  generally 
satisfactory,  as  gold  runs  fairly  true  to  weight.  The  variation 
on  account  of  coins  which  have  become  worn  more  than  usual 
is  negligible.  Having  weighed  a  thousand  dollars  worth,  the 
balance  may  then  be  weighed  and  the  weight  translated  into 
terms  of  dollars. 

In  some  organizations  there  will  be  a  general  cashier  who 
will  have  a  general  petty  cash  fund,  and  who  will  in  turn,  dis- 
tribute smaller  amounts  to  other  employes.  This  is  especially 

36 


OUNTING    THE    CASH 

apt  to  be  true  in  hotels.  The  men  behind  the  desk  where  the 
guests  go  to  register  are  known  as  front  desk  clerks.  These 
clerks  usually  act  as  cashiers  and  have  their  individual  cash  funds. 
In  addition  there  will  be  funds  in  the  possession  of  the  cashiers 
at  the  bar.  cigar  counter  and  in  the  restaurant.  It  is  always 
advisable  to  make  inquiry  in  the  beginning  before  starting  to 
count  the  cash  whether  there  are  any  funds  other  than  those 
held  by  the  general  cashier.  It  is  sometimes  embarrassing  to 
proceed  with  the  audit  and  find  petty  disbursements  coming  in 
from  one  source  or  another  and  upon  inquiry  to  discover  that 
there  are  a  number  of  individuals  throughout  the  organization 
who  have  petty  cash  funds.  If  the  question  had  been  asked  in 
the  beginning  and  the  cash  all  counted  at  one  time,  there  would 
not  have  been  any  possibility  of  one  party  passing  money  to 
another  to  make  up  shortages.  When  the  cash  count  is  started 
it  should  be  completed  as  soon  as  possible  so  that  one  employe 
will  not  have  an  opportunity  to  pass  the  word  along  to  another, 
or  perhaps  furnish  him  with  enough  to  make  up  the  shortage. 
\Yhen  counting  the  cash  of  two  individuals  who  are  in  close 
proximity  one  to  the  other,  both  individuals  should  be  kept  con- 
stantly in  sight  by  the  auditor  so  that  no  assistance  in  the  way 
of  supplying  cash  may  be  rendered  one  to  the  other. 

It  is  preferable  if  possible,  that  the  cash  be  counted  on  the 
last  day  of  the  period  which  the  audit  covers.  This  remark 
applies  with  equal  force  to  notes  and  securities.  If  the  fact  that 
an  audit  is  to  be  made  for  the  year  ending  June  30  is  known 
some  time  prior  to  June  30  it  is  well  to  arrange  to  count  the 
cash  on  June  30  if  possible.  This,  of  course,  cannot  always  be 
done  because  of  the  fact  that  many  times  it  is  not  known  that 
an  audit  will  be  made  until  long  after  the  period  has  closed.  A 
client  may  not  decide  to  have  the  accounts  audited  until  after 
the  close  of  the  fiscal  year.  In  such  a  case  the  next  best  thing 
may  be  done,  namely,  count  the  cash  and  securities  immediately, 
or  do  it  the  first  thing  upon  taking  up  the  work.  After  the 
count  has  been  finished  and  the  balance  compared  with  the  bal- 
ance in  the  cash  book,  the  balance  should  be  "worked  back"  to 
the  date  on  which  the  period  covered  by  the  audit  closed. 

The  illustration  which  follows  attempts  to  present  a  sheet 
of  journal  paper  showing  the  manner  in  which  the  record  of 
the  cash  count  appears. 

37 


PRINCIPLES  OF   AUDITING 


22. 


2£_ 


-,* 


\£f^ 


COUNTING   THE    CASH 

In  the  foregoing  illustration  Mr.  Rockwell  is  the  name  of  the 
man  who  handles  the  cash,  that  is,  the  man  who  is  responsible 
for  it;  the  cashier  or  the  man  whose  cash  was  counted.  The 
count  shows  silver  dollars,  altho  not  very  many.  Silver  dollars 
are  not  numerous  in  the  North  and  East,  but  in  the  South  and 
West  are  frequently  encountered  in  large  quantities.  The  reason 
for  segregating  the  money  according  to  denominations  is  that  an 
error  may  be  easily  located  if  it  exists.  Suppose  for  example, 
the  cash  were  $10.00  out  and  the  count  had  not  been  kept  sep- 
arately according  to  denominations.  In  attempting  to  discover 
the  error  it  would  be  necessary  to  count  all  the  money.  Where 
the  bills,  gold  and  silver  are  kept  separately  and  each  class  of 
denominations  is  shown  separately,  recounting  the  ten-dollar  bills 
or  the  ten-dollar  gold  pieces  may  lead  quickly  to  the  discovery 
of  the  error,  in  which  case,  it  will  not  be  necessary  to  recount 
further.  Concerning  the  I.  O.  U.'s  and  checks  it  is  important 
that  the  date  as  well  as  the  name  of  the  maker  and  amount  should 
be  set  down.  The  I.  O.  U.'s  and  checks  which  have  been  in  the 
cash  for  any  considerable  length  of  time  will  naturally  call  for 
explanation.  It  is  not  necessary  for  the  auditor  at  this  time  to 
express  any  opinion  as  to  these  items.  He  should,  however,  at 
the  time  when  they  are  before  him  make  a  complete  record  of 
them  and  set  down  any  explanation  concerning  them  which  may 
be  made  to  him  while  the  explanation  is  fresh  in  his  mind.  The 
vouchers  shown  will  probably  be  receipts  for  small  amounts  which 
have  been  paid  out  by  the  cashier  and  for  which  at  the  time  of 
the  count  he  has  not  yet  received  reimbursement  or  has  not 
turned  in. 

The  result  of  the  cash  count  as  per  the  foregoing  illustra- 
tion is  shown  to  be  $2,628.22.  The  count  was  made  on  February 
12,  1915.  The  balance  shown  by  the  account  should  agree  with  the 
balance  in  the  cash  book  on  February  12,  at  the  hour  when  the 
count  was  made.  In  order  that  this  may  be  so  it  will,  of  course,  be 
necessary  that  all  items  of  receipts  and  disbursements  shall  have 
been  entered  by  the  cashier  up  to  that  time.  It  may  be  found 
that  the  cashier  has  not  had  an  opportunity  to  enter  all  receipts 
and  disbursements,  in  which  case  such  opportunity  should  be  af- 
forded in  order  that  the  proper  balance  may  be  struck  and  the 
balance  agreed  with  the  count. 

Assuming  that  the  balance  in  the  cash  book  has  been  agreed 

39 


PRINCIPLES  OF   AUDITING 

with  the  count,  the  following  tabulation  shows  what  is  meant  by 
working  back  the  cash : 

February  12,  1915,  balance  per  cash  book,  p.  263 $2,628.22 

Add  disbursements,  January  2  to  February  12 5,785.13 

$8,413.35 
Deduct  receipts,  January  2  to  February  12 5,632.94 

Balance  December  31,  per  cash  book,  p.  257 $2,780.41 

If  any  difficulty  is  experienced  in  understanding  this  tabula- 
tion, the  items  may  be  reversed,  when  the  procedure  will  prob- 
ably be  seen  at  once.  The  vouchers  and  figures  as  they  appeared 
in  the  cash  book  were  as  follows : 

Balance,  December  31 $2,780.41 

Receipts,  January  2  to  February  12 5,632.94 

$8,413.35 
Disbursements,  January  2  to  February  12 5,785.13 


Balance,  February  12 $2,628.22 

It  should  be  noted  that  the  real  figure  with  which  the  auditor 
is  concerned  ultimately  is  the  balance  of  December  31.  It  is  that 
he  has  been  trying  to  prove.  Since  he  was  not  able  to  count  the 
cash  on  that  date  he  has  availed  himself  of  the  first  opportunity 
and  used  the  intervening  transactions  as  a  means  of  checking 
the  amount  which  it  is  claimed  was  on  hand  on  December  31.  The 
figures  as  shown  by  the  cash  book  covering  these  intervening 
transactions  may  be  accepted  for  the  present  and  the  amounts  of 
receipts  and  disbursements  respectively  determined  by  footing 
the  items  representing  them  in  the  cash  book. 

While  the  following  suggestion  may  be  a  valuable  one,  it 
should  be  put  into  practice  only  with  discretion.  Cashiers  whose 
funds  were  counted  and  found  correct,  have  at  times  been  found 
short  when  the  cash  was  counted  a  second  time.  This  procedure 
should  not  be  set  down  as  a  general  rule.  It  should  only  be  put 
into  practice  when  the  auditor  has  reason  to  feel  dissatisfied 

40 


COUNTING   THE    CASH 

with  the  first  count.  It  is  not  always  possible  to  confirm  a  sus- 
picion when  counting  the  cash  the  first  time.  It  is  not  always 
diplomatic  to  suggest  any  irregularity  even  if  the  suspicion  is 
present.  It  is  not  always  tactful  to  show  signs  of  dissatisfaction 
if  the  person  whose  cash  is  being  counted  does  not  perform  in 
every  way  as  absolute  honesty  dictates  he  should.  In  such  cases, 
or  where  the  auditor  has  any  reason  not  to  feel  perfectly  satis- 
fied with  the  count  or  the  conditions  under  which  it  was  made, 
he  may  count  the  cash  a  second  time  during  the  audit  or  at 
the  end  of  the  engagement  just  before  leaving. 


CHAPTER  VIII 

COUNTING  THE  NOTES  AND  SECURITIES 

After  having  finished  counting  the  cash  the  notes  receivable 
should  be  taken  up  and  counted.  Notes  receivable  are  like  cash 
and  securities,  in  that  they  may  move.  For  the  purpose  of 
recording  these,  analysis  paper  will  probably  be  found  more 
satisfactory  than  journal  paper  because  of  the  need  to  spread 
out  the  information  and  classify  it  through  the  use  of  the  col- 
umns on  the  paper.  The  sheet  should  be  headed  up  with  the 
name  and  address  of  the  client  or  organization  to  which  the 
notes  belong.  Each  note  should  be  examined  and  listed,  setting 
down  in  each  case  the  following  information;  date  of  the  note, 
name  of  the  maker,  the  amount,  date  of  maturity  and  rate  of 
interest.  Some  notes  may  not  carry  interest.  If  so,  the  fact 
should  be  noted.  Failure  to  make  a  memorandum  of  this  kind 
may  cause  the  accountant  to  come  to  a  false  conclusion  later 
on  when  accruing  interest,  and  perhaps  after  he  has  left  the 
office  of  the  client,  that  he  failed  to  set  down  the  rate  of  interest 
on  the  note  in  question.  If  the  memorandum  is  made  at  the  time 
the  note  is  examined  such  alarm  will  be  avoided.  Notes  are 
made  in  two  ways;  one  kind  reads  substantially,  "I  promise  to 
pay  John  Smith  one  thousand  dollars — 60  days  hence  with  in- 
terest at  6%."  The  other  kind  reads :  "Sixty  days  after  date  I 
promise  to  pay  John  Smith  one  thousand  and  ten  dollars  without 
interest."  In  consequence  of  such  variation  notes  should  be 
scrutinized  very  carefully. 

As  a  memorandum  the  names  of  any  indorsers  appearing  on 
the  notes  should  be  taken  down.  It  sometimes  happens  that  a 
concern  will  take  a  note  from  a  corporation  if  the  note  bears  the 
personal  indorsement  of  some  officer  of  the  corporation,  when 
it  would  not  accept  the  note  otherwise.  A  count  of  notes  in  a 
certain  case  recently  revtaled  just  that  situation.  The  notes  were 
those  of  a  corporation  not  at  all  well  known,  but  in  which  a 
prominent  inventor  was  interested  financially.  It  had  been  the 
custom  of  the  client  to  accept  notes  from  the  corporation  in  ques- 
tion only  in  case  they  were  indorsed  by  a  well-known  individual. 
One  or  two  notes  out  of  some  nine  or  ten  had  come  through 

42 


COUNTING  THE   NOTES  AND  SECURITIES 

which  had  not  borne  the  usual  indorsement,  had  passed  the  cashier 
and  been  filed  away  without  the  oversight  having  been  noticed. 
The  absence  of  the  indorsement  was  discovered  by  the  auditor 
in  examining  the  notes.  It  was  quite  important  that  the  excep- 
tion to  the  rule  should  have  been  noted  and  the  attention  of  the 
client  called  to  the  fact  that  he  had  in  his  possession  one  or  two 
pieces  of  paper  not  as  strong  as  the  others,  or  at  least  not  as 
strong  as  he  desired  to  have  them. 

The  auditor  will  have  occasion  at  some  subsequent  time  either 
to  calculate  or  check  the  accrued  interest.  On  this  account  it 
is  extremely  important  that  all  facts  concerning  the  notes  and 
interest  be  made  a  matter  of  record  in  his  working  papers  so 
that  such  work  may  be  done  at  any  time,  even  after  he  has  left 
the  office  of  the  client.  He  should  put  some  mark  of  identifica- 
tion on  the  notes  when  they  are  counted,  in  order  that  others 
may  not  be  substituted  and  that  he  will  be  fortified  in  case  a 
dispute  of  any  kind  arises  and  it  becomes  necessary  for  him  to 
state  specifically  just  what  he  saw  and  counted. 

Securities  embrace,  generally  speaking,  stocks,  and  bonds,  and 
bonds  and  mortgages.  Analysis  paper  is  more  convenient  for 
listing  securities  than  journal  paper.  Such  should  be  headed  up 
with  the  name  and  address  of  the  organization  and  a  description 
of  the  contents  of  the  sheets ;  also  the  date  that  the  securities 
were  counted  and  the  hour.  Stocks  may  be  considered  first.  The 
stock  certificates  should  be  examined  to  see  that  they  stand  in 
the  name  of  the  organization  whose  accounts  are  being  examined, 
or  are  indorsed  in  blank.  It  sometimes  happens  in  close 
corporations,  where  the  stock  is  perhaps  all  held  by  one  individual, 
except  such  shares  as  are  necessary  to  qualify  directors,  that  stock 
certificates  will  appear  in  the  name  of  the  principal  individual 
concerned.  The  stock  that  is  owned  by  a  corporation  should 
appear  in  the  name  of  the  corporation,  or  if  the  stock  happens  to 
be  in  the  name  of  the  individual,  it  should  either  be  transferred  or 
assigned  in  blank. 

The  list  should  show  with  regard  to  each  kind  of  stock  held — 
the  name  of  the  company  that  issued  it,  the  number  of  shares  or 
the  kind  of  shares  (preferred  or  common),  the  par  value  of  each 
share,  the  par  value  of  the  block  of  shares  held,  and  whether  or 
not  the  stock  is  fully  paid  and  non-assessable. 

Care  should  be  exercised  with  regard  to  stock  on  which  in- 

43 


PRINCIPLES  OF  AUDITING 

stalments  have  been  paid.  A  certificate  will  now  and  then  be 
found  which  appears  on  casual  observation  to  be  a  stock  certifi- 
cate for  one  thousand  shares,  par  value  $100,  amounting  at  par 
to  $100,000.  If  this  certificate  is  examined  carefully  there  will 
be  found  perhaps  in  one  corner  or  on  the  margin  a  statement  to 
the  effect  that  25%,  or  the  first  instalment  only,  has  been  paid. 
While  this  is  an  exception  to  the  rule  that  stock  should  not  be 
issued  until  paid  for,  it  is  nevertheless  true  especially  where 
large  amounts  are  concerned  that  stock  certificates  are  issued 
with  the  indorsement  as  to  the  instalments  thereon  which  have 
been  paid.  It  will  make  considerable  difference  in  trying  to  bal- 
ance out  the  total  of  the  list  against  the  securities  ledger,  if  in 
such  cases,  stock  is  listed  as  fully  paid  when  in  fact  a  percentage 
only  has  been  paid. 

In  the  case  of  bonds,  analysis  paper  should  be  used  for  list- 
ing and  the  sheet  headed  up  the  same  as  for  stocks.  The  list 
should  show  with  regard  to  each  kind  of  bonds  held  (after  having 
been  examined  and  counted)  the  name  of  the  company  which 
issued  the  bond,  a  complete  and  accurate  description  of  each, 
par  value  of  each  bond,  par  value  of  the  block  of  bonds  and 
the  date  of  maturity,  the  rate  of  interest  and  the  dates  on  which 
the  interest  is  payable.  Each  bond  should  be  examined.  If  a 
coupon  bond,  the  coupon  should  be  scrutinized  to  see  that  the  next 
one  coming  due  as  well  as  all  the  succeeding  coupons  are  attached 
and  intact.  Provision  also  should  be  made  on  the  analysis  paper, 
through  appropriate  columns,  for  the  accrued  interest  and  in  some 
cases,  for  amortization  and  accumulation.  It  is  not  probable  in  a 
small  organization  where  there  are  few  investments  and  they  are 
small  in  amount  that  amortization  and  accumulation  would  need 
to  be  considered.  Where  the  reverse  is  true,  they  are  matters  of 
importance. 

With  regard  to  the  accuracy  of  the  description,  a  word  or 
two  should  be  said.  There  are  at  least  two  good  reasons  why 
the  auditor  should  be  particular  about  describing  a  bond  accu- 
rately. Accuracy  begets  confidence.  One  can  never  tell  when 
this  information  may  be  needed.  There  is  no  end  of  embarrass- 
ment when  the  information  is  not  accurate.  There  is  an  equal 
amount  of  satisfaction  when  the  information  is  accurate.  In 
attempting  to  verify  the  figure  at  which  bonds  are  carried,  ref- 
erence is  usually  had  to  some  publication  like  the  Commercial 

44 


COUNTING  THE   NOTES  AND  SECURITIES 

and  Financial  Chronicle  or  the  daily  papers  for  the  purpose  of 
getting  quotations.  Whether  or  not  the  correct  quotation  is  ob- 
tained will  depend  in  certain  instances  on  the  description.  For 
example,  the  Chicago,  Milwaukee  and  St.  Paul  General  4's  were 
issued  in  series.  Series  "A"  will  mature  in  1952,  series  "B" 
in  1962,  series  "C"  in  1972.  In  looking  up  the  different  quota- 
tions on  these  different  series  it  will  be  found  that  they  are  quoted 
as  follows:  series  "A"— 78,  series  "B"— 87,  series  "C"— 93.  It 
will  be  seen  consequently  that  failure  to  note  the  series  in  a  case 
of  this  kind  will  later  make  a  difference  of  from  ten  to  twenty 
points  in  the  valuation. 

The  information  concerning  the  rate  of  interest,  the  dates  on 
which  the  interest  is  payable,  etc.,  will  be  needed  either  in  order 
to  make  or  check  the  accruals  of  interest  and  to  determine  very 
often  whether  or  not  the  interest  has  been  properly  treated.  A 
bond  may  be  bought  at  102  and  accrued  interest  and  carried  on 
the  books  at  $1,035.27,  for  example.  Three  things  in  reality 
have  been  bought;  a  par  value  principal,  a  premium  and  some 
accrued  interest.  When  the  coupon  is  paid  it  will  be  based  on 
the  par  value  principal,  but  a  part  of  the  total  of  the  coupon  will 
be  earned  during  the  period.  The  interest  should  be  divided 
into  two  parts.  One  part  should  be  credited  to  the  accrued 
interest  and  the  other  to  interest  earned.  It  is  important  that  all 
facts  concerning  interest  should  be  available  in  order  that  the 
treatment  of  the  interest  may  be  properly  checked.  This,  for 
example,  might  involve  ascertaining  whether  or  not  the  whole 
amount  of  the  coupon  in  such  case  had  been  credited  to  interest 
earned  and  the  accrued  interest  which  attached  to  the  bond  when 
it  was  purchased  allowed  to  remain  as  an  asset,  or  whether 
the  amount  of  the  coupon  had  been  properly  apportioned  and 
treated. 

Where  bonds  are  found  in  which  coupons  have  been  de- 
tached inquiry  should  be  made  immediately  to  ascertain  the 
reason.  Such  an  inquiry  should  of  course  be  tempered  with 
judgment  in  case  it  is  quite  apparent  that  the  coupons  have  been 
detached  for  collection.  If  such  is  the  case,  however,  the  coupon 
should  be  traced  through  and  checked  out. 

It  might  also  happen  that  bonds  are  out  for  the  purpose  of 
being  registered  as  to  principal  or  interest.  Where  this  is  the 
case  a  memorandum  should  be  made  as  to  the  particulars  con- 

45 


PRINCIPLES  OF  AUDITING 

cerning  them  and  they  should  be  examined  at  some  later  date. 
It  is  always  advisable  that  they  be  seen  sooner  or  later,  altho 
in  some  instances  where  litigation  is  going  on  they  may  be  held 
by  some  trustee.  In  extreme  cases  it  may  be  necessary  to  obtain 
from  a  trustee  or  the  registrar  a  certificate  to  the  effect  that  the 
bonds  are  being  held. 

Again  in  the  case  of  bonds  and  mortgages  analysis  paper 
should  be  used  for  listing  the  documents.  They  should  be  ex- 
amined and  a  record  made  of  the  date,  the  name  of  the  maker, 
the  amount,  the  date  of  maturity,  the  rate  of  interest  and  the  dates 
on  which  the  interest  is  payable,  if  specified.  Two  documents 
or  instruments  are  involved,  the  bond  which  is  the  evidence  of 
indebtedness  and  the  mortgage  which  is  the  security  for  the  bond. 
It  is  the  bond  which  should  be  examined  for  the  information 
just  mentioned.  The  mortgage  should  be  scrutinized  to  see  how 
it  is  made,  by  and  in  whose  favor  and  whether  or  not  in  favor 
of  the  client.  If  not  so  made  it  should  be  properly  assigned. 
The  examination  should  include  verification  of  the  fact  that  it 
was  signed,  witnessed  and  recorded. 

In  connection  with  the  matter  of  record  it  sometimes  hap- 
pens that  bonds  and  mortgages  will  at  the  time  of  counting  the 
securities  be  out  for  the  purpose  of  being  recorded.  In  certain 
counties  in  New  York,  owing  to  the  vast  amount  of  work  of 
this  character,  it  sometimes  requires  a  considerable  length  of 
time  to  have  the  record  effected.  Consequently  in  extreme  cases 
it  may  be  desirable  to  get  a  certificate  from  the  county  clerk  to 
the  effect  that  certain  mortgages  are  being  held  for  record. 

Incident  to  the  matter  of  record  it  is  important  that  the  audi- 
tor in  examining  the  bonds  and  mortgages  in  New  York  should 
watch  for  mortgages  recorded  between  July,  1905  and  July,  1906, 
and  be  sure  that  the  entire  mortgage  tax  for  such  period  has 
been  paid.  The  tax  on  some  mortgages  executed  during,  this 
period  still  remains  partially  unpaid. 

Insurance  policies  on  property  covered  by  mortgages  should 
be  requested  and  inspected  to  see  that  the  property  is  amply 
protected.  A  mortgage  on  a  building  would  not  be  of  much 
value  if  the  building  were  to  burn  and  not  be  protected  by  in- 
surance. One  who  holds  a  mortgage  usually  sees  to  it  that  the 
property  is  insured  and  usually  insists  that  the  insurance  policy 
be  filed  with  the  person  holding  the  mortgage. 

46 


COUNTING  THE  NOTES  AND  SECURITIES 

Tax  receipts  should  also  be  produced  as  evidence  of  the  fact 
that  the  taxes  have  been  paid  up.  Since  a  tax  lien  on  property 
takes  precedence  over  everything  else  it  is  highly  important  that 
the  value  of  the  property  be  not  impaired  in  this  respect. 

Among  miscellaneous  securities,  in  addition  to  the  three  classes 
above  discussed  may  be  found  certificates  of  indebtedness,  cer- 
tificates of  deposit,  warehouse  receipts,  scrip,  receipts  for  pay- 
ment on  account  of  capital  stock,  subscriptions  and  evidences  of 
syndicate  participations.  While  these  may  not  include  every- 
thing with  which  the  auditor  may  come  in  contact  they 
are  sufficiently  indicative  of  what  is  meant  by  miscellaneous 
securities. 

As  a  word  of  advice  to  the  young  and  inexperienced  auditor, 
it  may  be  said  that  he  is  justified  in  taking  as  much  time  as  he 
needs  to  properly  read  and  interpret  the  miscellaneous  docu- 
ments above  mentioned.  He  should  not  be  afraid  to  take  all 
the  time  necessary  to  read  them  through  in  order  to  find  out 
what  they  are.  He  should  not  allow  anybody  to  worry  him  or 
hurry  him  until  he  has  satisfied  himself  in  this  particular.  He 
is  charged  with  the  duty  of  passing  judgment  on  such  instru- 
ments and  it  is  .vital  to  him  that  he  should  not  pass  anything 
without  knowing  exactly  what  it  is  and  being  satisfied  con- 
cerning it.  He  should  never  hesitate  to  take  down  all  the  facts 
and  all  the  details  which  he  thinks  necessary.  While  tact  is  of 
course  important,  he  should  bear  in  mind  that  he  is  not  counting 
the  securities  in  order  to  accommodate  the  man  in  whose  cus- 
tody they  may  be  found,  but  rather  to  verify  the  fact  of  their 
existence  and  propriety  as  an  investment. 


CHAPTER  IX 

TAKING  OFF  THE  TRIAL  BALANCE 

The  preliminary  work  having  been  completed  possibly  the 
next  thing  to  be  done  is  to  have  the  pass  book  sent  out  to  be 
balanced.  It  will  sometimes  happen  that  the  pass  books  have 
recently  been  balanced  and  the  persons  concerned  in  sending 
them  out  will  hesitate  to  do  so.  The  auditor  should,  it  seems, 
insist  on  having  them  sent  again  if  necessary.  While  this  pro- 
cedure is  not  absolute  proof  against  collusion,  it  tends  to  pre- 
vent it  and  to  discover  it  if  it  exists.  It  is  not  considered  suffi- 
cient as  a  rule  to  accept  the  balance  shown  in  a  pass  book  even 
after  it  has  been  balanced  a  second  time,  for  the  reason  that 
there  may  have  been  collusion  between  some  clerk  in  the  bank 
and  some  employe  of  the  company.  In  addition  to  having  the 
pass  book  balanced,  a  certificate  signed  by  some  proper  officer 
of  the  bank,  setting  forth  the  amount  of  the  balance  should 
be  obtained.  The  auditor  will  be  called  upon  either  to  write  a 
letter  to  the  bank  requesting  a  certificate,  or  to  send  out  a  form 
letter  containing  the  request.  The  request  in  either  case  should 
have  the  approval  of  the  client  before  being  sent  to  the  bank. 
The  bank  should  be  asked  to  return  the  certificate  to  the  auditor 
direct  and  not  through  the  client  or  his  office.  It  is  important 
that  the  letter  should  be  approved  by  the  client  since  it  is  not 
customary  for  banks  to  furnish  information  concerning  balances 
of  depositors  upon  request  without  the  approval  of  the  depositor. 
The  question  has  sometimes  arisen  as  to  whether  or  not  banks 
have  the  right  to  give  out  such  information  without  the  permis- 
sion of  the  depositor.  Banks  have  frequently  held  that  such 
information  is  confidential  and  have  refused  to  divulge  the 
condition  of  a  despositor's  account  without  a  court  order.  Speci- 
mens of  the  letter  and  blank  form  above  mentioned  will  be 
found  following: 

48 


TAKING  OFF  THE  TRIAL  BALANCE 


Jones  and  Parker, 

Certified  Public  Accountants, 

32  Waverly  Place, 

New  York  City. 

February  12,  1915. 

Second  National  Bank, 

Fifth  Avenue  and  27th  Street, 

New  York  City. 

Gentlemen : 

In  connection  with  our  examination  of  the  accounts  of  the 
Warburton  Desk  Company,  we  are  desirous  of  verifying  the 
amount  on  deposit  with  you  to  the  credit  of  said  company  at 
the  close  of  business  on  February  12,  1915. 

Will  you  oblige  us  therefore  by  sending  your  certificate  to 
our  office  at  the  above  address? 

Yours  very  truly, 

(Signed)  Jones  and  Parker, 

Certified  Public  Accountants. 
Approved : 


A  letter  such  as  the  above  would  probably  be  used  by  an  ac- 
countant with  a  small  business  or  dealing  with  small  concerns. 
Many  of  the  larger  firms  of  accountants  deal  with  large  organi- 
zations which  have  numerous  bank  accounts.  It  is  not  unusual 
for  railroads  to  have  from  forty  to  fifty  such  accounts.  Where 
there  is  occasion  to  request  a  great  many  certificates,  the  audi- 
tors frequently  avail  themselves  of  a  blank  form.  This  form 
is  perforated,  the  upper  part  being  a  letter  addressed  to  the  bank 
while  the  lower  part  is  a  certificate  to  be  filled  out  by  the  bank. 

49 


PRINCIPLES  OF  AUDITING 


JONES   &    PARKER 

32  WAVERLY  PLACE 
NEW  YORK 


•M  York,  IrtruMy  12. 


Dear   Silt: 

Please  complete  ind  m«il  to  us,  in  the  accompanying  stamped  and  addressed  envelope,  the  attached 

certification  in  respect  "'         Th«  WETbUTten  DMlC   CO«P4gy      _ — - 

lor  which  we  extend  our  thanks  in  anticipation  of  your  prompt  attention 
APPROVfQ  Yours  very  truly, 


MESSRS.   JONES  4   PARKER,  COPYUU 

Certified    Public   Accountant*  No 1. 


Dear  SITS: 

At  the  rinse  of  business  on       MbTMIT  11,    1915  >      'h»  balance  on  our  books  to  1he_0t*4l  t  —  , 

•MK8M 

ot  T&«  nxturton  9«ik  COKPUQT 

^,,  ymir   ^inuaiamil    thrao   hunflr*,fl   tW«nty—«tTiB  fipfl   S8/100     nnllar«  l.t    4,32"f.M          1 

in  the  period  from     B«c«art)«r  31,  1914  ,  to      T«tru*ry  12,  1915, 

Inclusive,  we  credited  or  paid  said      Til*  VfcTtmrton  Dok   Comp*ny  Interest  to  the  tola!  amount  of 

_  nona  _  ,  _  Dollars  ($___aom  _  ) 


At  the  close  of  business  on     f«6niATy  12,    1913,    said    &•   ffcTDUTton  MlK 

was  obligated   or   indebted   to  us  on   loans,   notes,   participations,   or   other   accounts  or   contracts,   as  follows- 
_  i  _  IQBA  _ 


By 

-191 *THIe). 


TAKING   OFF   THE   TRIAL   BALANCE 

It  will  be  noted  in  connection  with  this  form  that  there  are 
certain  inquiries  made  other  than  that  contained  in  the 
first  letter  mentioned.  Small  organizations  are  not  so  apt  to 
have  complicated  relations  with  banks  as  larger  ones.  Getting 
certificates  from  a  bank  very  often,  however,  uncovers  matters 
not  disclosed  by  the  client  or  his  employes.  The  author  re- 
cently had  occasion  to  request  a  certificate  from  a  certain  bank 
and  took  the  letter  personally  to  the  manager  of  the  branch 
where  the  account  was  located.  On  presenting  the  letter  he 
was  asked  which  account  he  desired.  He  promptly  replied  that 
he  wished  to  know  the  balances  of  all  the  accounts.  He  re- 
ceived balances  of  three  accounts  instead  of  one,  the  two  addi- 
tional accounts  being  special  ones  which  had  been  concealed. 

In  a  similar  manner  the  opposite  form  letter  may  develop  the 
existence  of  additional  accounts  of  loans  and  interest  which  may 
affect  the  situation. 

Banks,  as  a  rule,  are  very  accommodating  in  the  matter  of 
furnishing  certificates.  They  sometimes  object,  however,  to  giv- 
ing the  details  of  interest  credited  to  the  account,  except  such 
interest  as  may  have  been  credited  since  the  pass  book  was  last 
balanced.  Some  banks  which  render  a  statement  every  month 
in  which  the  interest  is  included,  ignore  the  matter  of  interest 
entirely  in  so  far  as  a  certificate  is  concerned,  since  they  feel  that 
the  monthly  statement  which  they  render  should  furnish  sufficient 
verification  for  the  auditor. 

The  matter  of  having  the  pass  books  balanced,  out  of  the  way, 
attention  may  be  devoted  to  the  taking  off  of  the  trial  balance. 
Before  that  is  discussed,  however,  a  word  or  two  may  be  said 
relative  to  making  a  list  of  the  books.  Some  accountants  ad- 
vocate getting  a  list  of  all  the  books  used  by  the  client  before 
proceeding  with  the  work.  Other  accountants  ridicule  the  idea. 
Making  such  a  list  may  be  scientific  procedure.  On  the  other 
hand,  doing  so  may  give  the  impression  that  the  auditor  is  in- 
experienced and  attempting  to  follow  some  set  of  rules  in  doing 
the  work.  The  auditor  who  understands  his  business  should  be 
familiar  with  all  the  books  generally  used.  If  it  so  happens  that 
the  peculiarities  of  certain  lines  of  business  require  special  and 
unusual  books,  the  fact  will  become  apparent  during  the  course 
of  the  audit  and  should  occasion  no  embarrassment  if  the  audi- 
tor is  sufficiently  self-possessed  to  ascertain  the  function  of  the 

51 


PRINCIPLES  OF  AUDITING 

book  or  form  even  though  it  is  unfamiliar  to  him.  Professional 
pride  is  a  very  worthy  attribute.  It  should  not,  however,  be 
allowed  to  stand  in  the  way  of  getting  information.  It  is  no 
reflection  on  an  auditor  that  he  is  not  familiar  with  every  book 
and  form  which  exists.  There  is  no  reason  why  he  should  hesi- 
tate to  confess  this  fact.  Consequently  there  is  no  reason  why 
he  should  not  be  perfectly  frank  in  asking  about  any  book  or 
form  which  he  does  not  understand.  It  seems  therefore  that  it 
is  not  necessary  and  perhaps  undesirable  on  account  of  the  im- 
pression that  it  may  make,  to  prepare  a  formal  list  of  the  books. 
This  argument  is  not  against  GO  doing  in  the  case  of  an  engage- 
ment where  the  man  in  charge  desires  to  be  systematic  in 
planning  the  work  of  himself  and  his  assistants  and  makes  a 
memorandum  list  as  an  aid  in  laying  out  the  work. 

By  this  time  the  auditor  will  probably  be  ready  to  take  a 
trial  balance  of  the  general  ledger.  The  general  ledger  is  the 
key  to  the  whole  situation.  Everything  is  supposed  to  be  sum- 
marized therein.  If  an  auditor  were  to  begin  with  the  ends  and 
work  toward  the  center,  it  is  probable  he  would  find  some  diffi- 
culty in  tying  up  his  results.  It  is  customary  to  begin  with  the 
control  which  the  general  ledger  is  presumed  to  present,  and 
work  from  that  as  a  basis. 

Whether  the  auditor  should  take  the  trial  balance  of  the  gen- 
eral ledger  himself  or  accept  one  which  has  been  prepared  and 
furnished  to  him,  is  perhaps  a  question.  Tact  will  probably  dic- 
tate that  he  accept  such  trial  balance  if  offered  to  him.  There 
is  no  occasion  for  hurting  a  person's  feelings  by  refusing  to 
consider  such  an  offer  of  assistance.  The  author  is  strongly  in 
favor  of  having  the  auditor  take  his  own  trial  balance.  Not 
because  of  the  fact  that  he  is  suspicious  of  the  one  offered  to 
him,  or  too  proud  to  admit  that  the  bookkeeper  is  not  compe- 
tent to  take  a  good  trial  balance,  but  because  of  the  fact  that  it 
offers  an  opportunity  to  the  auditor  to  familiarize  himself  with 
the  business  and  its  transactions.  He  cannot  help,  in  going  over 
the  accounts  one  by  one,  thinking  about  them  and  in  being  obliged 
to  spend  the  necessary  time  on  each  account  in  order  to  take 
the  balance  off,  build  up  in  his  mind  as  he  goes  along,  a  general 
idea  regarding  the  organization  as  a  whole  together  with  its  dif- 
ferent ramifications  and  functions.  This  is  not  only  true  of  the 
first  time  which  he  handles  the  engagement  but  any  repetition 

52 


TAKING  OFF   THE   TRIAL   BALANCE 

of  same.  The  act  of  taking  off  the  trial  balance  even  on  repeti- 
tion of  the  engagement,  gives  him  an  opportunity  to  refresh 
his  memory. 

It  might  be  well  here  to  say  that  the  books  are  not  ready  to 
be  audited  if  they  are  not  in  balance.  The  auditor  should  not 
proceed  with  the  work  if  the  books  are  not  in  balance  until  he 
has  discussed  the  matter  with  the  proper  party  and  had  an  un- 
derstanding as  to  what  he  is  to  do.  As  a  theoretical  matter,  at 
least,  auditing  is  not  accounting,  and  if  the  auditor  is  obliged 
to  finish  writing  up  the  books,  make  entries,  hunt  out  errors  and 
put  books  in  balance,  he  is  doing  bookkeeping  or  accounting 
work  and  not  auditing.  As  a  practical  proposition,  doing  such 
work,  unless  specifically  agreed  to,  is  apt  to  result  to  his  preju- 
dice. If  the  work  is  being  done  under  a  contract,  and  the  time 
necessary  to  do  the  work  has  been  estimated,  putting  in  a  lot  of 
time  finding  mistakes  in  bookkeeping,  is  apt  to  result  in  a  loss 
on  the  engagement.  If  the  work  is  being  done  on  a  per  diem 
basis,  the  auditor  is  apt  to  become  involved  in  a  disagreeable  dis- 
cussion with  the  client  because  of  the  fact  that  time  has  been 
spent  in  doing  work  which  should  have  been  done  by  the  em- 
ployes of  the  client.  If  a  situation,  such  as  the  one  above  sug- 
gested arises,  it  should  be  brought  to  the  attention  of  the  proper 
authority  immediately  without  proceeding  with  the  work  and 
the  client's  wishes  in  the  matter  ascertained.  While  this  may 
delay  the  engagement  somewhat,  it  will  be  found  more  satis- 
factory in  the  end. 

In  taking  off  the  trial  balance  two  sheets  of  analysis  paper 
should  be  used.  Each  sheet  should  be  headed  up  with  the  name 
of  the  organization  and  marked  "trial  balance,  general  ledger 
before  or  after  closing,"  as  the  case  may  be,  with  the  date.  One 
sheet  should  be  used  for  the  debits  and  one  for  the  credits.  The 
sheets  should  be  so  arranged  that  the  first  column  of  each  will 
be  used  for  the  ledger  folio,  the  second  and  third  columns  for  the 
titles  of  the  accounts,  the  fourth  column  for  references,  the  fifth 
column  for  amounts.  This  arrangement  provides  for  the  begin- 
ning of  a  working  sheet,  so  that  the  columns  to  the  right  of  the 
fifth  may  be  used  respectively  for  the  debit  and  credit  adjust- 
ments and  the  final  balance  sheet  and  income  statement  figures. 
This  will  leave  three  columns  (if  12  column  paper  is  used)  for 
notations  on  accounts  which  do  not  require  extensive  analysis. 

53 


PRINCIPLES  OF  AUDITING 

If  more  than  one  sheet  is  required,  either  in  the  case  of  debits 
or  credits,  the  sheets  should  be  numbered  with  a  separate  series 
for  debits  and  credits  in  the  upper  right  hand  corner.  In  the 
majority  of  cases  there  will  be  more  debits  than  credits.  These 
perhaps  are  small  matters,  but  it  is  a  knowledge  of  these  little 
things  and  attention  to  them  which  may  make  the  difference 
between  success  and  failure  in  the  case  of  the  young  man  start- 
ing in.  Too  many  accountants  are  apt  to  forget  the  fact  that 
someone  else  at  a  later  date  may  have  occasion  to  use  the  same 
working  papers.  There  is  nothing  more  annoying  than  to  go 
back  into  old  working  papers  and  be  unable  to  get  any  informa- 
tion from  them  without  spending  hours  in  digging  it  out.  On 
the  other  hand,  there  is  nothing  more  satisfactory  than  to  refer 
to  old  papers  and  find  them  not  only  full  of  comprehensive  in- 
formation but  so  arranged  and  labeled  that  the  information  may 
be  obtained  quickly.  A  folder  of  working  papers  may  contain  a 
number  of  trial  balances.  If  they  are  not  properly  labeled  and 
described  they  are  apt  to  be  of  little  value  and  to  cause  great 
annoyance  to  the  person  referring  to  them.  If  the  trial  balance 
is  not  properly  labeled  and  becomes  lost  from  the  folder,  there 
may  be  no  way  of  getting  it  back  to  its  proper  place  even  if  it 
happens  to  be  found. 

Another  minor  point  which  the  young  man  should  keep  in 
mind,  is  that  he  should  always  write  his  name  on  all  papers  which 
he  makes.  Seniors  have  been  frequently  heard  to  utter  words 
which  are  unprintable  because  in  going  over  working  papers 
they  were  not  able  to  discover  who  did  the  work.  Papers  which 
are  not  clear  in  themselves  may  frequently  be  cleared  up  by 
getting  in  touch  with  the  man  who  made  them.  If  it  is  impos- 
sible to  find  out  who  did  the  work  there  is  little  possibility  of 
clearing  up  the  points  in  question.  Attention  to  these  little 
matters  on  the  part  of  the  junior  frequently  engenders  a  feeling 
in  favor  of  such  a  man.  In  fact,  his  continuation  on  the  staff 
at  the  time  when  men  are  being  dropped  on  account  of  lack  of 
work  may  depend  on  just  such  little  things  as  these.  Many 
times  a  senior  is  asked  when  starting  out  on  an  engagement, 
which  men  he  wishes  to  assist  him.  Knowing  the  men  who 
are  available  he  goes  over  them  mentally  one  by  one.  In  the 
decision  the  man  who  is  careless  about  details,  a  poor  writer, 
or  slovenly  in  his  work,  is  apt  to  be  eliminated.  A  man  who 

54 


TAKING  OFF  THE  TRIAL   BALANCE 

is  careful  about  everything,  and  dependable,  and  a  man  who  is 
known  to  produce  finished  work,  is  apt  to  get  the  call.  Being 
repeatedly  chosen  under  such  circumstances  tends  to  serve  as  a 
recommendation  and  to  make  a  favorable  impression  upon  the 
office  manager  or  member  of  the  firm.  Being  constantly  refused 
or  criticised  tends  to  produce  the  opposite  impression. 

On  taking  off  the  trial  balance,  each  item  should  be  proved 
by  deducting  the  footings  in  the  respective  accounts  one  from 
the  other,  instead  of  taking  the  balance  for  granted  because  it 
has  been  jotted  down  in  pencil  in  the  ledger.  What  appears 
from  a  pencil  notation  to  be  the  correct  balance  may,  in  fact,  be 
an  old  one.  Its  inclusion  in  the  trial  balance  may  produce  an 
incorrect  result.  The  ledger  should  be  paged  through  to  the  end. 
That  is  to  say,  each  page  should  be  turned  over  and  examined. 
This  procedure  should  be  carried  through  to  the  end  of  the  book. 
The  auditor  sometimes  has  difficulty  in  getting  a  trial  balance 
because  of  the  fact  that  one  or  more  amounts  have  been  omitted. 
Sometimes  a  bookkeeper  for  one  reason  or  another  will  run  the 
accounts  along  page  after  page  and  then  suddenly  skip  a  num- 
ber of  pages  and  go  on.  Sometimes  most  of  the  accounts  will 
be  shown  page  after  page  beginning  at  the  front  of  the  book  witL 
the  profit  and  loss  account  or  the  surplus  account  or  the  pro- 
prietors' account  on  the  last  page  of  the  book.  There  is  no 
accounting  for  the  manner  in  which  the  minds  of  some  book- 
keepers work.  There  is  no  accounting  for  some  of  the  things 
which  they  do.  The  auditor  must  therefore,  in  taking  off  a 
trial  balance,  guard  against  the  idiosyncrasies  of  bookkeepers. 

Following  out  the  thought  above  suggested,  subsidiary  ac- 
counts will  sometimes  be  found  in  the  general  ledger  mixed  in 
with  the  general  ledger  account.  Sometimes  memorandum  ac- 
counts which  have  no  place  in  the  classification  will  appear.  Cus- 
tomers' and  creditors'  detailed  accounts  as  well  as  the  control- 
ling accounts  therefor  are  put  into  the  general  ledger  because 
there  is  room  for  them.  All  these  things  have  to  be  kept  in 
mind  and  guarded  against. 

Another  thing  which  should  be  remembered  is  that  the  trial 
balance  should  contain  a  cash  account.  Someone,  for  some 
reason  or  other,  launched  the  theory  a  few  years  ago  that  if  a 
cash  book  was  used  it  was  not  necessary  to  have  a  cash  account 
in  the  general  ledger.  It  would  be  just  as  sensible  to  say  that 

55 


PRINCIPLES  OF   AUDITING 

because  a  customer's  ledger  is  used  it  is  not  necessary  to  have  a 
customer's  controlling  account  in' the  general  ledger.  Likewise, 
it  might  be  contended  because  there  is  a  book  for  notes  receiv- 
able in  which  they  are  entered  when  they  are  received  and  a 
line  drawn  through  them  as  they  are  paid,  it  would  not  be  nec- 
essary to  have  an  account  for  notes  receivable  in  the  general 
ledger.  The  balances  taken  from  the  general  ledger  should  yield  a 
trial  balance  of  accounts.  All  other  information  necessary  to  a 


TAKING   OFF   THE   TRIAL   BALANCE 

trial  balance  should  be  included  therein,  not  excepting  the  cash 
account.  Anyone  who  favors  good  practice  should  not  permit 
an  argument  on  this  point. 

The  illustrations  will  show  how  the  trial  balance  would 
appear  on  the  analysis  sheet  at  this  point,  and  also  offer  in 
a  way,  the  suggested  outline  which  the  discussion  will  follow. 

It  is  to  be  understood  that  the  items  appearing  in  the  trial 
balance  are  such  as  might  appear  in  any  ordinary  case.  The 


57 


PRINCIPLES  OF  AUDITING 

classification  of  accounts  shown  therein  is  not  ideal  or  exhaustive 
by  any  means.  It  presents  a  typical  case  and,  in  fact,  offers  a 
better  opportunity  for  study  than  an  ideal  classification. 

A  word  in  explanation  of  the  working  sheet  and  its  opera- 
tion as  used  by  the  auditor  may  not  be  amiss  at  this  point.  The 
trial  balance  according  to  the  ledger,  represents  the  figures  as 
shown  by  the  bookkeeper.  Whatever  errors  are  discovered  dur- 
ing the  audit  will  require  adjustment  in  the  auditor's  report.  In 
other  words,  if  there  is  a  difference  between  the  figures  shown 
by  the  bookkeeper  and  the  correct  figures,  the  auditor  will  present 
the  correct  figures.  It  is  important  that  the  auditor  shall  be  able 
to  explain  the  difference  and  to  establish  the  connection  between 
the  figures  as  reported  by  him  and  the  figures  shown  in  the 
books,  if  necessary.  It  is  the  working  sheet  which  offers  an 
ideal  opportunity  for  this  very  thing.  If  the  auditor  will  make 
for  his  own  papers,  memorandum  journal  entries  covering  the 
errors  discovered,  or  any  adjustments  which  may  be  necessary, 
and  will  on  the  working  sheet,  post  these  journal  entries  in  the 
adjustment  column,  he  will  then  be  able,  by  applying  these  debits 
and  credits  in  the  adjustment  columns  to  the  figures  in  the  trial 
balance  column,  to  arrive  at  the  correct  results,  which  may  then 
be  distributed  into  the  balance  sheet  and  income  statement  col- 
umns. In  this  way  the  connection  between  one  set  of  figures 
and  the  other  is  clearly  established  and  explained.  The  memo- 
randum journal  entries  just  referred  to  may  be  attached  to  the 
trial  balance  in  support  of  the  figures  in  the  adjustment  columns. 
It  will  be  apparent  at  any  future  time  and  to  anyone  subse- 
quently taking  up  the  matter,  exactly  what  happened.  The 
auditor  will  also  have  the  correct  and  final  figures  from  which 
to  prepare  his  report 


What  to  Do  During  an  Audit 


CHAPTER  X 

READING  THE  MINUTES 

The  precise  order  which  should  be  followed  in  making  an 
audit  is  a  matter  which  is  perhaps  open  to  discussion.  It  de- 
pends very  much  on  personal  choice.  Reading  the  minutes  im- 
mediately after  having  completed  the  trial  balance,  seems  to  be 
the  next  logical  step,  however.  The  reading  of  the  minutes  gives 
one  an  insight  into  the  organization;  it  prepares  one  to  do  in- 
telligent work ;  it  suggests  whom  to  consult  in  case  any  informa- 
tion is  needed ;  and  in  short,  it  enables  one  to  size  up  the  whole 
situation  before  going  further  with  the  work. 

In  the  case  of  a  corporation,  the  minutes  of  the  stockholders, 
the  minutes  of  the  directors,  or  executive  committee,  or  any 
special  committees  should  be  read.  The  auditor  should  also  ask 
for  the  contract  filed  or  copies  of  any  contracts  which  are  in 
existence. 

On  a  sheet  of  journal  paper  he  should  make  an  abstract  from 
the  minutes  of  the  stockholders.  He  should  do  likewise  in  the  case 
of  the  other  minutes  above  mentioned.  If  the  certificate  of  in- 
corporation is  not  embodied  in  the  minutes  of  the  stockholders, 
he  should  ask  to  see  a  copy  of  the  articles  of  incorporation  or  a 
certificate  of  incorporation.  These  words  are  used  interchange- 
ably at  times.  The  articles  of  incorporation  are  also  referred  to 
as  the  charter.  The  charter  should  be  examined  if  a  copy  is 
available,  or  if  not,  a  certificate  executed  by  the  secretary  of 
state.  There  should  be  jotted  down  on  the  journal  paper,  the 
exact  name  of  the  corporation,  the  date  the  certificate  was  filed, 
the  authorized  capital  stock  showing  the  par  value  and  the  kind 
of  stock  if  there  is  more  than  one  class,  and  the  par  value  of 
each  share.  There  should  also  be  noted  the  names  of  the  in- 
corporators,  and  it  may  be  important  to  make  a  note  of  whether 
or  not  directors  must  be  stockholders.  All  these  little  matters 
may  become  necessary  in  writing  the  comments.  If  such  occa- 
sion presents  itself  it  is  well  to  have  all  the  facts  at  hand.  It 
would  be  very  embarrassing  for  an  auditor  who  had  done  a 
piece  of  work  in  Arizona  to  be  back  in  New  York  and  wish  to 
know  the  date  on  which  a  certificate  of  incorporation  was  filed 

61 


PRINCIPLES  OF  AUDITING 

if  he  did  not  have  the  information.  There  are  certain  things 
which  in  writing  comments  must  be  said  with  exactness.  If  it 
is  necessary  to  give  the  date  on  which  a  corporation  came  into 
existence,  it  is  the  exact  date  and  nothing  else  which  is  required. 
To  say  about  January  7  or  about  January  9  is  not  sufficient.  The 
auditor  is  expected  to  be  accurate. 

Glancing  through  the  by-laws  will  show  the  powers  and 
duties  of  the  officers.  While  the  information  may  be  superfluous 
to  many,  it  is  possible  that  certain  readers  will  find  it  helpful  to 
have  recorded  here  the  general  duties  of  the  officers.  The  presi- 
dent is  ordinarily  required  to  preside  at  meetings  of  stockholders 
and  directors,  to  present  a  report  at  the  annual  meeting,  to  ap- 
point and  remove,  employ  and  discharge,  and  fix  the  compensa- 
tion for  all  servants  and  agents,  employes  and  clerks,  sign  all 
contracts  and  agreements,  all  certificates  of  stock,  countersign 
the  checks,  notes,  drafts,  warrants  or  other  orders  for  the  pay- 
ment of  money.  The  vice-president  usually  performs  these  duties 
in  the  absence  of  the  president,  and  in  addition  any  duties  which 
may  be  assigned  or  delegated  to  him.  In  large  organizations 
where  there  are  several  vice-presidents,  one  may  have  charge  of 
the  purchasing,  for  example,  whereas  another  has  charge  of  the 
sales.  The  secretary  keeps  the  minutes,  serves  notices,  has  the 
custody  of  the  records  and  seals,  keeps  the  stock  and  transfer 
books,  attends  to  the  correspondence  and  lays  matters  before 
the  directors  at  the  request  of  the  president  or  shareholders.  The 
treasurer  has  the  care  and  custody  of  funds  and  securities.  He 
has  the  power  to  sign,  make  or  endorse  in  the  name  of  the  com- 
pany, all  checks,  notes,  drafts  or  warrants  for  payment  of  money, 
sign  all  certificates  of  stock  and  render  financial  statements.  This 
latter  would  probably  be  true  only  in  the  case  of  companies  which 
do  not  have  a  comptroller.  It  is  usually  the  duty  of  the  comp- 
troller, where  such  office  is  provided  for,  to  prepare  and  render 
the  financial  statements.  The  by-laws  will  usually  contain  a 
provision  concerning  the  bond  of  the  treasurer.  The  minutes 
should  also  be  scrutinized  for  any  action  taken  by  the  stock- 
holders in  the  matter  of  authorizing  the  issue  of  bonds  or  placing 
mortgages  on  the  property,  or  ratifying  the  action  of  the  direc- 
tors in  so  doing.  In  certain  states  mortgages  may  not  be  placed 
on  company  property  until  approved  or  ratified  by  two-thirds  of 
the  stockholders. 

62 


READING   THE    MINUTES 

As  a  practical  matter  it  would  perhaps  be  wise  to  note  the 
date  of  the  annual  meeting  in  order  that  the  auditor  may  have 
in  mind  if  he  does  not  already  know,  the  time  at  which  his  report 
will  probably  have  to  be  in  the  hands  of  the  company.  Some- 
times it  is  necessary  to  get  the  report  in  so  that  it  may  be  printed 
and  placed  before  the  stockholders  at  the  annual  meeting.  Fur- 
ther notation  might  be  made  of  the  compensation  of  directors 
and  as  a  matter  of  curiosity  perhaps,  whether  an  auditing  com- 
mittee is  provided  for,  and  if  so,  what  the  duties  of  the  members 
are.  As  a  matter  of  fact,  the  auditing  committee  sometimes  em- 
ploys an  accountant  to  do  the  work  and  make  the  report  to  the 
committee. 

The  minutes  of  the  stockholders  should  be  examined  with 
regard  to  the  election  of  officers,  the  compensation  of  officers, 
extra  compensation,  bond  of  the  treasurer,  depositary  or  de- 
positaries, contracts  with  manager,  contracts  for  the  purchase 
of  a  business,  resolutions  fixing  the  value  of  property  purchased 
and  the  rates  of  depreciation,  etc.  There  may  also  be  found  in 
the  minutes  of  the  directors,  provisions  concerning  the  bonds 
of  employes  other  than  the  treasurer,  altho  as  a  rule  such  mat- 
ters are  left  to  the  president  with  power  to  fix  the  amount  of 
such  bonds. 

The  executive  committee  consists,  as  a  rule,  of  three  mem- 
bers. It  is  simply  a  small  committee  from  among  the  directors 
for  the  purpose  of  facilitating  certain  features  of  the  work.  The 
financial  side  of  the  concern  is  usually  looked  after  by  the  execu- 
tive committee.  This  committee  often  outlines  the  financial  pro- 
gram and  makes  appropriations,  etc. 

The  auditor  should  examine  co-partnership  agreements,  joint 
venture  agreements,  operating  or  selling  contracts,  and  in  each 
instance  make  an  abstract  showing  the  date,  parties  to  the  con- 
tract, period  to  be  covered  and  the  substance  of  it.  If  at  all 
probable  that  the  information  may  be  needed  later  on,  important 
parts  of  the  contract  should  be  copied  word  for  word.  No  time 
will  be  wasted  in  thoroughness  in  this  particular.  It  would  be 
preferable  to  spend  an  hour  or  half  a  day  if  necessary  copying 
something  that  might  never  be  of  any  use,  rather  than  to  fail 
to  get  information  which  might  be  vital  in  the  future  to  litiga- 
tion. This  precaution  is  especially  desirable  in  out  of  town  en- 
gagements. It  may  possibly  be  of  interest  to  have  presented  a 

63 


PRINCIPLES  OF  AUDITING 

practical  illustration  of  what  one  might  come  in  contact  with  in 
reading  over  minutes.  The  illustration  is  taken  from  the  work- 
ing papers  of  an  engagement  in  the  New  York  University  division 
of  applied  accounting.  It  is  an  abstract  of  the  minutes  of  the 
executive  board  of  a  certain  organization,  the  name  of  which  as  it 
appears  being  fictitious,  relative  to  operations  for  the  year  ended 
September  30,  1914.  In  this  organization  the  governing  board 
instead  of  being  the  board  of  directors  or  board  of  trustees  was 
called  the  executive  board. 


READING    THE    MINUTES 


^^-, 


. 


£^ 


:& 


M 

^ 


ffCO.  CO 


•~C-4-^s'  <ff 


O.  O<3       -« 


a~        /  0  O. 


^ 


^^ 


.g^^^x. 


V,^/ 


~7/ 


CHAPTER  XI 

THE  MECHANICAL  WORK 

The  work  to  be  taken  up  next  is  what  is  sometimes  referred 
to  as  the  mechanical  work.  Mechanical  work  may  be  divided, 
generally  speaking,  into  three  classes — vouching,  footing  and 
checking  postings.  By  vouching  is  meant  checking  entries  from 
supporting  papers.  The  entry  appearing  on  the  books  is  not 
accepted  as  being  final  and  conclusive.  Some  further  evidence  or 
support  is  considered  necessary. 

The  vouching  will  be  found  necessary  in  connection  with  the 
following  books : 

General  cash  book 

Petty  cash  book 

Purchase  journal  or  voucher  register 

Purchase  returns  and  allowances 

Sales  book 

Sales  returns  and  allowances 

In  addition  there  may  also  appear  at  times  a  payroll  book.  It 
is  probable,  however,  that  vouching  in  connection  with  payroll 
books  is  becoming  less  and  less  frequent.  There  was  a  time  when 
it  was  customary  to  find  a  receipt  for  each  employe  on  the  pay- 
roll, that  is,  a  receipt  purporting  to  be  signed  by  such  employe. 
The  reason  for  a  payroll  book  is  that  too  much  room  would  be 
taken  up  in  the  general  cash  book  if  there  were  to  be  entered 
therein  the  names  of  all  employes  who  received  wages  with  the 
amounts  received.  The  idea  of  a  payroll  book  follows  the  idea 
which  has  been  brought  out  before,  namely,  that  certain  classes 
of  items  have  been  withdrawn  from  the  cash  book  in  order  to 
facilitate  the  work  and  avoid  filling  un  page  after  page  in  the 
cash  book  with  names  and  amounts.  The  payroll  book  is  usually 
so  arranged  that  the  names  are  written  once  and  by  using  a 
columnar  book  with  short  pages,  the  amounts  are  entered  from 
month  to  month  opposite  the  corresponding  names.  This  has  the 
effect  of  course  of  a  special  cash  book  for  recording  payments  to 
employes  where  employes  are  numerous.  Vouchers  support- 
ing such  payments  are  not  always  satisfactory.  This  is  apt 

66 


to  be  true  in  organizations  where  the  number  of  employes  is 
so  great  that  many  of  them  are  not  known  personally  to  the 
cashier.  The  padding  of  payrolls  and  turning  in  of  fictitious 
receipts  is  perhaps  encouraged  rather  than  prevented  where  re- 
ceipts are  accepted  without  any  personal  knowledge  of  the  em- 
ploye on  the  part  of  the  cashier.  A  better  and  more  satisfactory 
scheme  consists  in  having  a  man  who  actually  pays  out  the 
money  to  the  individual,  and  who  must  be  a  trustworthy  em- 
ploye, initial  the  payroll  book  and  perhaps  give  a  voucher  for 
the  entire  amount.  The  ideal  scheme  is  to  have  the  individual 
employe  present  himself  at  the  office  and  receive  the  money 
from  the  cashier  in  the  presence  of  a  second  party.  This,  how- 
ever, in  large  plants  where  the  employes  are  numerous  results 
in  a  considerable  waste  of  time  and  is  frequently  objected  to  as 
being  uneconomical  in  this  respect.  Notwithstanding  what  has 
been  said,  payroll  books  are  frequently  found.  The  individual 
items  are  supported  by  signed  receipts  and  a  majority  of  them 
probably  should  be  examined. 

Footing  will  be  applied  to  the  following  books  as  a  rule : 

General  cash  book 

Petty  cash  book 

Purchase  journal  or  voucher  register 

Purchase  returns  and  allowances 

Sales  books 

Sales  returns  and  allowances 

Payroll  book 

General  journal 

General  ledger  accounts 

Customer  ledger  accounts 

Creditors  ledger  accounts 

It  may  appear  offhand  that  the  ideal  course  to  pursue  will  be 
to  foot  all  these  books.  That  this  is  not  necessary  will  prob- 
ably be  apparent  later  on.  As  specific  books  are  taken  up  in 
detail,  it  will  probably  be  found  that  the  footings  may  in  many 
cases  be  dispensed  with.  It  might  seem  ordinarily  that  because 
someone  has  made  all  these  footings  in  order  to  prove  them  the 
same  thing  must  be  done.  This  will  probably  be  found  unneces- 
sary in  certain  cases. 

67 


PRINCIPLES  OF  AUDITING 

In  the  matter  of  checking  postings  the  following  books  must 
be  considered : 

General  ledger 
from 

General  journal 
General  cash  book 
Petty  cash  book 
Purchase  journal 
Sales  journal 

Customers'  ledger 
from 

Sales  journal 

Sales  returns  and  allowances 

General  cash  book  or  (customers  cash  book) 

Creditors  ledger 
from 

Purchase  journal 

Purchase  returns  and  allowances 

General  cash  book 

No  attempt  has  been  made  here  to  indicate  more  than  gen- 
eral procedure.  It  is  planned  to  take  up  one  by  one  and  in 
detail  these  different  processes.  While  it  has  been  said  that  the 
customers'  ledger  should  be  checked  from  the  sales  book  and 
the  general  cash,  it  may  be  found  as  a  matter  of  fact  when 
the  customers'  ledger  is  checked  that  the  actual  procedure 
will  be  just  the  reverse.  The  above  arrangement  is  only  in- 
tended to  indicate  the  general  relation  of  the  books  and  the 
work  in  connection  with  them.  Just  as  it  is  considered  sufficient 
to  do  only  a  part  of  the  vouching  and  footing,  so  it  is  usually 
considered  sufficient  if  a  certain  proportion  only  of  the  postings 
are  checked. 

There  should  next  be  taken  up  the  vouching  of  the  cash 
book.  Before,  however,  going  into  the  detailed  work  of  vouch- 
ing, cash  books  in  general,  on  account  of  the  great  variety  they 
present,  should  be  discussed.  Cash  books  will  vary  in  size,  form 
and  ruling.  The  number  of  varieties  will  be  surprising.  There 

68 


THE    MECHANICAL    WORK 

is  one  thing,  however,  upon  which  dependence  may  be  placed 
and  that  is,  the  principle  that  a  cash  book  should  record  cash 
receipts  and  disbursements  no  matter  what  its  form,  size  or  rul- 
ing. It  is  the  function  of  a  book  always  which  must  decide 
what  the  book  is,  regardless  of  what  it  is  called  or  how  it  is 
constructed. 

The  volume  of  business  may  be  sufficiently  large  so  that  the 
cash  book  will  be  divided  into  two  parts,  one  for  receipts  and 
the  other  for  disbursements.  Suppose  for  example,  that  there 
are  a  great  number  of  cash  receipts  and  very  few  disburse- 
ments, or  a  great  part  of  the  cash  receipts  comes  from  cus- 
tomers. Instead  of  filling  up  the  general  cash  book  with  all 
these  details,  there  may  be  what  amounts  to  a  subsidiary  book 
for  cash  receipts  from  customers  showing  with  respect  to  each 
customer  the  amounts  received.  The  total  from  this  book  will 
then  be  carried  at  the  end  of  the  day  to  the  general  cash  book 
where  one  entry  for  customers  will  be  made.  On  the  other  hand, 
there  may  be  cases  where  the  receipts  will  be  large  in  amount 
but  few  in  number,  or  the  disbursements  small  in  amount  and 
great  in  number.  Under  such  circumstances  a  number  of  books 
for  disbursements  may  be  needed  from  which  the  totals  will  be 
carried  to  the  general  cash  book  in  which  one  entry  only  for 
the  day  will  be  made.  In  some  general  cash  books  where  either 
one  or  the  other  of  the  above  situations  prevails,  the  total  re- 
ceipts and  total  disbursements  will  be  shown  so  that  the  balance 
may  be  ascertained,  or  either  the  receipts  or  the  disbursements 
may  be  split  up  into  a  number  of  different  books  for  convenience. 
Books  combining  both  receipts  and  disbursements,  or  showing 
either  separately,  may  be  alternated  by  days.  One  cash  book 
may  be  used  for  the  odd  days  and  another  for  the  even  days. 
Such  alternation  is  usually  introduced  in  order  to  facilitate  post- 
ing. While  one  is  in  use  for  the  purpose  of  making  entries,  the 
other  is  being  used  for  the  purpose  of  posting  details  to  cus- 
tomers' or  creditors'  accounts.  Offices  which  are  run  twenty- 
four  hours  a  day  sometimes  have  a  cash  book  for  the  day  man 
and  another  for  the  night  man.  This  is  frequently  found  in 
hospitals  and  similar  institutions.  The  day  man  when  he  goes 
off  duty  will  turn  his  cash  book  over  to  the  night  man.  The 
night  man  will  post  from  the  book  during  the  night  so  that  in 
the  morning  everything  is  posted  up.  For  the  purpose  of  con- 

69 


PRINCIPLES  OF  AUDITING 

trolling  the  work  of  the  individuals,  the  night  man  is  compelled 
to  keep  his  receipts  and  disbursements  in  a  separate  book  as 
well  as  his  cash  in  a  separate  box  so  that  he  can  account  for  his 
balance  and  turn  it  over  in  the  morning.  These  possibilities  are 
mentioned  in  order  to  indicate  the  great  variation  and  the  possi- 
bility of  combination  which  exists  in  practice.  To  find  four  or 
five  different  cash  books  in  an  office  is  not  unusual. 

Variations  will  also  be  found  in  the  rulings.  One  kind  will 
have  two  money  value  columns  on  the  left-hand  page  and  two 
similar  columns  on  the  right-hand  page.  This  kind  may  per- 
haps be  found  in  a  bank  or  a  broker's  office.  The  kind  which 
is  probably  met  with  most  frequently  is  that  in  which  the  ruling 
is  especially  arranged  in  columns.  Beginning  on  the  left-hand 
page  at  the  left  side  of  the  page  there  is  the  column  for  the 
date.  This,  going  from  left  to  right,  is  followed  by  a  narrow 
column  or  columns  for  posting  references,  with  subsequent  col- 
umns for  the  name,  explanation,  net  cash,  discount,  customers 
and  general  ledger  items.  The  ruling  on  the  right-hand  page 
is  precisely  the  same.  The  headings  for  the  columns  are  the 
same  except  that  the  word  "creditors"  is  substituted  for  "cus- 
tomers." A  further  variation  of  this  idea  consists  in  introduc- 
ing two  additional  columns  for  bank  deposits  and  withdrawals. 
This  will  be  found  with  the  deposits  at  the  extreme  right  of 
the  left-hand  page  and  the  withdrawals  at  the  extreme  left 
of  the  right-hand  page.  When  the  book  is  opened  these  two 
columns  will  appear  in  the  center  of  the  double  page.  Where 
there  are  more  bank  accounts  than  one,  additional  columns  are 
introduced. 

In  an  institution  or  an  association,  the  accounts  for  which 
are  run  on  a  cash  instead  of  an  accrual  basis,  a  cash  book  still 
different  in  ruling  is  liable  to  be  found.  Where  a  cash  basis  is 
used  it  is  customary  to  find  a  considerable  number  of 
columns  taking  the  place  of  the  general  ledger  columns  in  order 
that  the  income  and  expense  may  be  classified.  Under 
this  basis  the  income  is  apt  to  be  in  the  form  of  cash 
receipts.  The  expense  is  liable  to  take  the  form  of  cash  dis- 
bursements. This  situation  gives  rise  usually  to  a  long  book 
which  may  look  very  much  like  a  purchase  journal  or  voucher 
register.  There  are  many  cases  in  which  a  purchase  journal 
is  used  where  the  accounts  are  kept  in  this  way,  but  such  a 

70 


THE    MECHANICAL    WORK 

situation  really  modifies  the  true  cash  basis  and  the  principal 
purpose  of  the  columnar  cash  book  as  just  described  is  to 
provide  for  distribution. 

It  may  not  be  amiss  to  reiterate  that  the  form  or  arrange- 
ment of  a  cash  book  does  not  affect  the  function.  Knowing 
what  the  function  of  the  cash  book  is,  it  should  not  make  any 
difference  what  physical  means  are  employed  for  exercising  the 
proper  function.  The  function  of  the  cash  book  is  to  show  the 
receipts  and  disbursements  of  cash  and  the  balance  resulting 
therefrom.  The  work  of  auditing  a  cash  book  should  consist  in 
verifying  the  items  which  make  up  the  receipts  and  the  disburse- 
ments, not  only  in  detail  but  in  aggregate,  and  proving  the 
balance  by  inspection  of  the  cash  in  hand,  or  the  certificate  of 
the  depositary  or  both.  It  is  necessary  to  include  both  because 
of  the  fact  that  sometimes  the  balance  in  the  cash  book  is  all 
represented  by  cash  in  hand;  sometimes  by  cash  in  hand  and 
cash  in  bank.  Sometimes  the  cash  is  all  in  one  bank  and  some- 
times in  several. 

Verification  of  the  receipts  may  be  first  considered.  This 
operation  so  far  as  the  auditor  is  concerned,  is  not  always  as 
satisfactory  as  it  might  be.  There  is  little  hope  of  laying  down 
rules  which  will  be  absolutely  proof  against  exception.  All  one 
may  hope  to  do  is  to  indicate  enough  of  the  general  principle 
involved,  or  to  state  rules  of  a  general  nature,  so  that  the  novice 
may  exercise  his  ingenuity  in  applying  the  principles  when  he 
comes  in  contact  with  these  things  in  practice.  It  is  not  probable 
that  the  young  man  will  have  as  his  first  experience  that  of 
plunging  into  the  audit  of  a  municipality,  a  railroad,  or  a  bank, 
alone.  If  his  experience  happened  to  be  in  the  organization  of 
any  one  of  these  three  kinds,  it  would  probably  be  under  the 
supervision  of  someone  else.  What  seems  desirable,  therefore, 
is  to  discuss  the  matter  in  its  relation  to  the  kind  of  organiza- 
tion with  which  the  young  man  is  most  liable  to  come  into  con- 
tact in  the  earliest  years  of  his  experience.  Such  organizations 
are  mercantile,  manufacturing  and  trading,  and  institutions.  The 
mercantile  or  the  manufacturing  and  trading  organization  de- 
rives its  principal  receipts  from  cash  sales  and  cash  received 
from  customers.  Miscellaneous  receipts  are  derived  from  a 
number  of  different  sources,  and  may  be  said  to  consist  princi- 
pally of  interest  on  bank  balances,  notes  receivable  and  interest 

71 


PRINCIPLES  OF   AUDITING 

thereon,  interest  on  bonds  and  dividends  on  stocks.    These  items 
do  not  exhaust  the  list  but  serve  rather  as  typical  illustrations. 

The  cash  sales  may  usually  be  verified.     The  entries  in  the 
general  cash  for  cash  sales  may  be  supported  usually  in  one  of 
three  ways.     First,  cash  register  slips  or  a  daily  record  taken 
from  the  cash  register;  second,  duplicate  sales  slips;  third,  a 
detailed  memorandum  book.    The  form  of  record  in  these  differ- 
ent instances  will  differ.     In  the  case  of  the  cash  register,  all 
that  will  be  obtainable  will  be  the  mechanical  total  for  the  day's 
receipts.     This  may  be  shown  either  by  slips  taken  from  the 
machine  or  the  record  which  is  kept  in  the  daily  cash  book  fur- 
nished by   the   cash   register   company.     Duplicate    sales    slips 
will  probably  give  all  the  details  of  the  transaction,  so  that  the 
auditor  may  go  back  as  far  as  he  likes  on  slips  of  that  kind.    It 
will  usually  be  found  that  such  slips  have  been  totaled  up  for 
the  day  in  some  manner,  either  on  the  adding  machine  or  per- 
haps on  the  comptometer  and  such  slips  will  usually  have  been 
preserved,  so  as  to  show  the  details  from  which  the  daily  totals 
were  made  up.    It  is  not  possible  to  check  the  items  where  totals 
are  obtained  through  the  use  of  the  comptometer,  because  such 
machine  does  not  list.     The  quickest  way  to  prove  such  totals 
is  to  have  the  slips  put  through  the  comptometer  a  second  time. 
It  is  not  probable  that  the  auditor  would  go  into  the  details  of 
the  work  to  such  extent.     If  the  slips  have  been  preserved  and 
are  presented  without  question,  the  presumption  is  that  there 
has  been  no  attempt  at  dishonesty.     Mistakes  may  have  been 
made  but  the  probabilities  are  that  they  are  slight  ones  and  not 
worthy  of  discovery.     It  is  not  probable  that  the  auditor  would 
check  up  the  total  sales  slips  against  the  daily  list  even  if  the 
adding  machine  list  were  available.     The  particular  point  to  be 
observed  is  that  the  slips  are  there  if  wanted. 

If  neither  of  the  two  foregoing  records  exist,  it  is  likely  that 
a  memorandum  book  will  have  been  kept.  It  may  be  just  a 
blotter  as  in  the  grocery  store  in  which  a  clerk  writes  down  3  Ibs. 
of  coffee  at  30  cents  under  the  name  of  Mrs.  John  Smith.  On 
the  other  hand,  not  as  much  information  as  the  foregoing  may 
be  found.  It  is  possible  that  only  the  item  of  90  cents  will  be 
entered  into  the  memorandum  book  in  the  money  column  and  the 
receipts  for  the  day  added  up.  In  some  manufacturing  concerns 
where  large  quantities  of  supplies  are  sold,  there  are  elaborate 

72 


THE    MECHANICAL    WORK 

systems  of  accounting  for  cash  sales.  Comparatively  few,  how- 
ever, it  is  thought,  make  a  record  of  the  articles  and  quantities 
sold.  Rather  than  not  it  is  apt  to  be  the  case  that  the  man  in 
the  stores  department  who  has  charge  of  the  sales,  jots  down  the 
amount  he  takes  in,  foots  up  the  total  at  the  end  of  the  day,  and 
at  the  end  of  the  day  or  month  turns  over  the  receipts  to  the 
cashier,  such  record  being  the  only  one  found. 

Cash  received  from  customers  has  in  the  past  been  a  most 
unsatisfactory  item  to  verify.  The  auditor  has  had  to  be  con- 
tent with  checking  the  amounts  against  the  customers'  accounts 
with  the  hope  that  before  the  audit  was  completed,  a  statement 
would  be  sent  to  each  customer  with  the  balance,  with  a  request 
for  confirmation,  and  in  that  way  a  partial  check  of  the  amount 
of  the  receipt  would  be  obtained.  Unfortunately  many  cus- 
tomers are  careless  about  returning  statements,  even  when  re- 
quested to  do  so,  all  of  which  interferes  with  the  completeness 
of  the  proposed  check.  There  has  recently  come  into  use  in  a 
somewhat  sporadic  way,  a  scheme  which  seems  to  be  an  excel- 
lent one,  not  only  from  the  point  of  view  of  the  merchant,  but 
also  that  of  the  accountant  or  auditor  who  is  called  upon  to 
verify  receipts  from  customers.  Within  the  past  year  a  number 
of  leading  department  stores  in  New  York  City  have  adopted 
the  scheme.  It  consists  in  using  a  perforated  invoice  so  that 
one  part  may  be  retained  by  the  customer  and  the  other  returned 
with  remittance.  The  invoice  has  been  used  in  two  ways.  The 
first  is  the  regulation  invoice  made  out  in  every  respect  as  for- 
merly, with  the  perforation  at  the  top  where  the  body  of  the 
invoice  begins.  If  the  customer  pays  by  check  and  no  receipt 
other  than  that  on  the  back  of  the  check  is  desired,  he  tears  the 
invoice  apart  at  the  point  of  perforation,  returns  the  upper  part 
showing  his  name,  address  and  ledger  folio,  as  well  as  the  amount, 
and  retains  the  lower  part  showing  the  items  and  total  amount. 
When  used  in  the  other  way,  the  invoice  is  of  the  same  form 
and  prepared  in  the  same  manner  as  before,  except  that  the  per- 
forated portion  is  at  the  bottom  and  duplicates  the  information 
relative  to  name,  address,  folio  and  amount  which  appears  at  the 
top  of  the  invoice.  In  this  case,  the  perforated  section  is  torn 
off  and  returned  with  the  check,  the  invoice  being  retained  by 
the  customer.  This  scheme  not  only  saves  postal  and  clerical 
labor  to  the  merchant  because  of  the  fact  that  he  has  no  receipted 

73 


PRINCIPLES  OF  AUDITING 

invoice  to  return,  but  it  furnishes  a  satisfactory  voucher,  as  it 
were,  to  the  auditor  in  support  of  the  receipts  from  customers. 
It  is  in  fact  a  remittance  slip.  It  comes  in  with  the  check.  The 
check  goes  to  the  cashier  to  be  entered  in  the  cash  book.  The 
remittance  slip  goes  to  the  bookkeeper  who  keeps  the  customers 
ledger.  This  procedure  facilitates  the  work  since  it  provides 
the  bookkeeper  with  something  to  post  from  immediately ;  at  the 
same  time  the  cashier  is  making  the  entry  if  desired.  The  re- 
mittance ultimately  goes  back  to  the  cashier  to  support  the  cash 
receipts.  The  use  of  this  scheme  by  an  increasing  number  of 
concerns  would  be  a  great  boon  to  the  accounting  profession. 
If  slips  of  this  kind  are  not  found  and  they  probably  will  not 
be  for  some  time,  until  the  practice  becomes  more  general,  about 
the  only  thing  to  do  in  so  far  as  the  verification  is  concerned,  is 
to  check  the  cash  received  against  the  customers'  accounts  to 
see  that  when  cash  was  debited  the  customers'  accounts  was 
credited.  This,  if  followed  up  later  by  sending  out  a  statement 
for  confirmation,  will  be  as  good  a  confirmation  as  an  auditor 
may  hope  for. 

With  regard  iu  miscellaneous  receipts,  no  fixed  rule  may  be 
laid  down.  Good  sources  of  verification  will  have  to  be  searched 
out  according  to  the  items  involved.  A  good  source,  for  ex- 
ample, with  regard  to  interest  on  bank  balances,  would  be  the 
usual  monthly  statements  which  some  banks  and  trust  companies 
send  depositors.  These  statements  show  the  amount  of  interest 
which  has  been  credited  to  the  depositor's  account.  There  might 
be  obtained  of  course  a  certificate  or  statement  from  the  bank 
or  trust  company,  showing  how  much  had  been  credited  during 
the  entire  year.  This  might,  however,  not  be  possible  as  such 
banks  might  take  the  position  that  having  rendered  a  monthly 
statement,  they  were  not  called  upon  to  go  further.  Some  judg- 
ment must  of  course  be  displayed  in  determining  how  diligent 
an  auditor  should  be  in  verifying  items  of  this  kind,  since  their 
size  and  importance  may  not  justify  the  expense  of  any  con- 
siderable time  in  order  to  verify  them. 

Interest  on  bonds  is  not  so  difficult  to  check.  Knowing  the 
par  and  the  amount  of  the  holding,  and  finding  out  the  rate  of 
interest  paid  and  the  dates  on  which  it  is  payable,  the  amount 
of  interest  received  or  receivable  should  be  determined  without 
difficulty. 

74 


THE    MECHANICAL    WORK 

Dividends  on  stocks  may  be  checked  through  newspaper  rec- 
ords such  as  dividend  notices,  or  reference  may  be  had  to  the 
Commercial  and  Financial  Chronicle,  or  Moody's  Manual. 

Institutions  and  associations  usually  derive  their  principal 
receipts  from  subscriptions,  donations,  dues,  collection  boxes,  col- 
lectors, and  in  the  case  of  hospitals,  pay  and  dispensary  patients. 
Miscellaneous  receipts  of  such  institutions  take  the  form  of  lega- 
cies and  bequests,  interest  on  bonds,  dividends  on  stocks  and 
interest  on  bank  balances. 

Some  subscribers  promise  to  pay  specific  sums  at  regular  in- 
tervals. It  may  be  found  that  since  these  promises  are  usually 
made  in  advance,  a  list  will  be  made  up  prior  to  the  day  that 
payment  is  due,  or  it  may  be  found  that  the  names  of  subscribers 
together  with  the  amounts  involved  are  placed  on  cards.  When 
the  payments  come  in  there  are  four  different  ways  in  which  the 
details  may  be  recorded.  First,  the  list  with  the  name  and 
amount  to  be  received  scratched  off,  indicating  that  it  has  been 
received;  second,  the  amount  of  the  payment  either  checked  on 
the  card  if  it  has  already  been  entered,  or  entered  on  the  individual 
card  either  front  or  back,  the  card  occasionally  taking  the  form 
of  a  small  ledger  account  where  the  subscriber  will  be  charged 
with  the  amount  subscribed  in  the  formal  way  and  credited  with 
the  money  when  it  comes  in ;  third,  a  stub  for  the  receipt  which 
has  been  sent  out;  fourth,  a  duplicate  or  carbon  of  the  receipt. 
The  last  is  the  best  form  since  a  copy  of  something  which  has 
gone  out  to  the  individual  is  available. 

There  is  a  way  of  checking  up  the  information  found  on  the 
stubs  or  entered  on  the  card  or  a  list,  namely,  publishing  a  list 
of  subscribers  with  the  amounts  subscribed.  This  is  done  by 
many  institutions.  Such  practice  seems  to  be  desirable  and  per- 
haps should  be  suggested  by  the  auditor  if  it  is  not  the  practice. 
A  person  subscribing  to  a  given  activity  upon  seeing  a  list  of 
subscribers  which  has  been  published,  immediately  looks  through 
the  list  to  find  his  name  and  ascertain  if  his  subscription  has 
been  reported  in  the  right  amount.  There  is  no  objection  to 
making  use  of  psychology  or  any  other  fair  means  of  verifying 
things  of  this  kind.  Sending  out  such  a  list  with  the  annual 
report  has  the  effect  of  an  automatic  check  on  the  subscriptions. 

What  has  been  said  of  subscriptions  may  be  applied  equally 
well  to  donations.  Donations  do  not  differ  from  subscriptions 

75 


PRINCIPLES  OF   AUDITING 

except  that  they  are  usually  smaller  in  amount  and  more  or  less 
infrequent  in  their  receipt.  Rarely  will  a  list  be  found  in  this 
respect.  They  may,  however,  be  accounted  for  through  stubs 
or  duplicates  or  carbons  of  receipts. 

Receipts  through  collection  boxes  are  most  unsatisfactory  to 
check.  Without  an  elaborate  organization  and  a  somewhat  elabo- 
rate mechanical  provision,  it  is  almost  impossible  for  a  society 
or  institution  to  tell  whether  or  not  all  collections  are  turned  in. 
The  auditor  has  very  little  opportunity  of  verifying  these  amounts. 
If  the  collection  boxes  are  placed  in  stores  or  other  public  places 
and  sealed  they  may  be  opened  and  the  contents  verified  in  the 
presence  of  some  representative  of  the  store,  for  example,  who 
furnishes  an  independent  certificate  as  to  the  amount. 

There  is  absolutely  no  way,  so  far  as  the  author  has  been  able 
to  discover,  after  having  given  what  seems  like  an  unwarranted 
amount  of  thought  to  the  matter,  whereby  receipts  taken  up  by 
collectors  on  the  street  and  in  other  public  places  may  be  veri- 
fied. The  institution  seems  to  be  at  the  mercy  of  these  collectors 
and  must  be  satisfied  with  whatever  is  turned  in. 

In  the  case  of  hospitals  where  some  patients  pay  board  a 
receipt  book  with  a  stub  or  carbon  copy  of  the  receipt  may  be 
found.  Such  institutions,  except  in  the  cases  of  the  largest  ones, 
are  not  apt  to  be  over-systematized  and  the  auditor  may  consider 
himself  fortunate  if  he  finds  the  name  of  the  patient  with  the 
amount  paid  and  the  date  entered  in  the  book.  There  is  little 
check  on  dispensary  patients  since  all  patients  do  not  pay.  While 
the  general  impression  is  that  dispensaries  arc  free,  it  is  probable 
that  most  of  them  exact  a  charge  of  those  who  are  able  to  pay. 
Some  dispensaries  it  should  be  said  to  their  credit  do  keep  records 
which  can  be  checked.  These  records  show  the  total  number 
of  patients  treated  in  each  clinic ;  the  number  of  those  who  paid 
and  the  number  who  were  treated  free  of  charge.  It  is  more 
than  apt  to  be  the  case  that  no  record,  even  such  as  that  of  a 
cash  register,  is  kept.  After  all,  as  a  practical  matter,  the  amount 
involved  is  usually  so  small  as  not  to  warrant  very  much  anxiety. 

Legacies  and  bequests  may  be  verified  by  correspondence 
which  will  be  found  in  the  files  or  can  be  produced.  If  the 
legacy  or  bequest  is  of  sufficient  size,  a  resolution  extending  the 
thanks  of  the  institution  will  usually  be  found  in  the  minutes  of 
the  governing  board.  These  items,  as  a  rule,  are  of  sufficient 

76 


THE    MECHANICAL    WORK 

size  and  importance  to  warrant  following  each  one  up  separately. 
Miscellaneous  receipts  in  the  case  of  institutions  may  also  be 
checked  in  the  same  manner  as  that  indicated  for  mercantile 
concerns. 

The  principle  involved  in  the  checking  of  receipts  is  to  get 
some  confirmation  from  the  second  party  to  the  transaction.  If 
such  outside  party  can  be  gotten  to  verify  the  transaction  it  is  a 
better  check  than  the  records  of  the  organization  undergoing 
audit.  It  need  not  be  expected  that  verification  will  be  gotten 
by  word  of  mouth  but  rather  through  some  communication  or 
statement  which  has  been  reviewed  by  the  second  party. 

No  matter  what  the  organization  may  be,  receipts  should  be 
checked  with  the  bank  deposits  to  see  that  all  receipts  have  been 
deposited  and  deposited  promptly.  The  checking  of  receipts 
insures  the  deposit  of  all  receipts  shown  but  not  necessarily  the 
entry  of  all  cash  actually  received.  Such  is  the  reason  for  going 
back  to  the  second  party  to  the  transaction.  The  mere  fact  of 
the  entry  of  the  amount  in  the  cash  book  being  shown  as  having 
been  deposited  in  the  bank  does  not  prove  that  all  the  money 
which  a  customer  paid  in  has  been  entered  in  the  books. 


CHAPTER  XII 


RECONCILING  THE  BANK  ACCOUNT 

At  this  point  it  is  probable  that  the  bank  account  or  accounts 
should  be  reconciled.  If  all  the  checks  are  drawn  on  one  bank 
and  entered  in  numerical  order,  it  may  be  possible  to  combine 
the  reconciliation  of  the  bank  account  and  the  vouching  of  the 
disbursements.  Take,  for  example,  a  case  where  the  checks  are 
all  on  one  bank  and  the  cash  book  appears  with  regard  to  the 
credit  side  in  accordance  with  the  illustration  below ; 


Date 

Check 
No. 

Payee 

Net 
Cash 

Discount 

Accounts 
Payable 

General 
Ledger 

The  returned  checks,  by  which  is  meant  checks  which  have 
been  paid  and  returned  by  the  bank,  may  be  found  arranged  in 
two  ways.  The  first  is  in  the  condition  in  which  they  were 
returned  by  the  bank,  namely,  done  up  in  packages  and  arranged 
in  accordance  with  the  order  in  which  they  were  paid  and  listed 
by  the  bank.  Otherwise,  they  will  appear  in  numerical  order  as 
issued.  Some  little  thought  needs  to  be  exercised  before  disturb- 
ing them  if  they  are  in  the  same  order  as  that  in  which  they 
were  returned  by  the  bank.  Finding  the  checks  in  the  original 
bundles,  as  they  were  returned  by  the  bank,  means  probably  that 
the  bank  account  has  not  been  reconciled  for  some  time.  Some 
banks  use  pass-books,  while  others  have  done  away  with  the 
pass-books  and  use  a  monthly  statement  on  which  the  paid 
checks  as  well  as  the  deposits  are  listed.  Having  in  mind  that 
the  account,  or  list,  as  the  case  may  be,  was  not  checked  up  at 
the  time  it  was  received,  the  lists  as  shown  by  the  bank  state- 
ment or  the  machine  lists  alone,  if  a  pass-book  is  used,  should 
be  checked  before  the  checks  are  put  in  numerical  order.  It  is 

78 


important  that  the  order  of  the  checks  be  not  disturbed  until 
each  statement  has  been  proved ;  otherwise  it  may  be  exceedingly 
difficult  to  allocate  the  trouble  in  case  a  difference  results  in  the 
attempted  reconciliation.  Taking  the  statement  for  the  month 
of  January,  for  instance,  the  returned  vouchers  should  be  checked 
against  the  entries  on  the  statement  or  against  the  machine  lists. 
The  machine  lists  should  be  footed,  since  it  is  not  safe  always 
to  accept  machine  footings.  The  machines  are  probably  accurate 
ninety-nine  times  out  of  a  hundred,  but  since  there  is  a  possi- 
bility of  their  becoming  deranged  and  not  giving  correct  results, 
it  is  always  safer  to  foot  machine  lists.  After  having  checked 
the  machine  footings  to  the  statement,  the  items  on  the  state- 
ment, both  debit  and  credit,  should  be  footed,  the  opening  bal- 
ance checked  from  a  preceding  statement  and  the  closing  balance 
proved.  Continuing  with  the  succeeding  months  in  the  same 
way,  if  all  are  found  to  be  correct,  the  checks  may  be  put  in 
numerical  order  since  breaking  up  the  order  in  which  they  came 
from  the  bank  is  no  longer  a  matter  of  importance.  In  putting 
the  checks  in  order  a  memorandum  should  be  taken  of  the  miss- 
ing numbers  and  reference  should  be  had  to  the  cancelled  checks 
in  order  to  ascertain  if  any  of  the  missing  numbers  are  repre- 
sented by  cancelled  checks.  In  the  case  under  illustration  here 
no  stub  book  is  used,  the  cash  book  takes  the  place  of  the  check 
book  and  the  checks  are  arranged  in  numerical  order  and  put 
up  in  pads.  Where  this  situation  does  not  exist,  reference  to 
the  stub  of  the  check  book  in  the  case  of  missing  numbers  will 
usually  show  whether  the  check  has  been  cancelled  or  is  in  reality 
outstanding.  Cancelled  checks  are,  where  good  practice  is  in 
force,  pasted  to  the  stub,  or  preserved  in  numerical  order. 

In  the  case  used  for  illustration  it  should  be  remembered  that 
there  is  no  check  book.  The  auditor  from  the  minutes  or  from 
some  other  source  will  have  ascertained  who  is  to  sign  and 
countersign  checks.  Remembering  further  that  the  process  is  a 
combined  one,  namely,  reconciling  the  bank  account  and  vouch- 
ing the  cash  disbursements,  the  procedure  will  be  as  follows : 

First:       Compare  the  number  of  the  check  with  the  number 

in  the  cash  book. 
Second :  Compare  the  payee  on  the  check  with  the  payee  in 

the  cash  book. 

79 


PRINCIPLES  OF   AUDITING 

Third:     Compare  the  amount  of  the  check  with  the  amount 

entered  in  the  cash  book. 
Fourth :  See  that  the  check  is  signed  by  the  proper  party  or 

parties. 
Fifth:       Put  a  small  double  tick  to  the  right  of  the  amount 

in  the  net  cash  column. 

There  now  arises  a  question  as  to  whether  or  not  the  check 
should  be  turned  over  and  the  endorsements  examined.  The 
author  is  aware  of  the  fact  that  certain  authorities  on  the  sub- 
ject recommend  turning  over  the  check  and  examining  the  en- 
dorsement, also  that  certain  teachers  advocate  the  same  thing. 
Personally,  he  is  of  the  opinion  that  the  auditor  need  not,  except 
under  certain  circumstances  concern  himself  with  the  endorse- 
ments if  the  check  has  passed  through  a  bank,  been  paid,  can- 
celled and  returned.  Several  years  ago  while  reconciling  an 
account  in  the  Market  and  Fulton  National  Bank,  the  follow- 
ing printed  statement  was  noticed  in  the  front  of  the  pass-book — 
"The  United  States  Courts  in  recent  decisions  have  held  that  a 
depositor  is  bound  personally  or  by  his  agent,  and  with  due 
diligence  to  examine  his  pass-book  or  statement  of  account,  and 
to  report  to  the  bank  without  unreasonable  delay,  any  errors 
which  may  be  discovered,  and  if  he  fails  to  do  so  and  the  bank 
is  thereby  misled  to  his  prejudice,  he  cannot  afterwards  dispute 
the  correctness  of  the  items  shown  in  the  pass-book."  The  thing 
which  stands  out  in  the  above  quotation  is  the  fact  that  the 
error  must  have  been  discovered  within  a  reasonable  time.  Most 
banks  nowadays,  either  in  their  pass-books  or  on  their  state- 
ments, notify  depositors  that  if  no  errors  are  reported  within 
ten  days,  the  account  will  be  considered  correct.  Ten  days  is 
probably  the  general  rule.  Ten  days  may  probably  be  considered 
as  a  reasonable  time  within  which  the  bank  must  be  notified. 
The  reason  for  this  precaution  on  the  part  of  the  bank  is  prob- 
ably not  the  fear  that  some  clerical  error  will  have  been  made 
in  balancing  the  pass-book  or  preparing  the  statement,  but  that 
the  money  will  have  been  paid  to  the  wrong  party.  This,  not- 
withstanding all  the  care  which  is  taken  in  paying  out  money 
on  checks.  It  is  difficult  for  a  stranger  who  presents  a  check 
at  a  bank  to  succeed  in  having  it  cashed.  Paying-tellers  invariably 
ask  for  identification  and  a  stranger  in  a  place  like  New  York 

80 


RECONCILING  THE  BANK  ACCOUNT 

City  might  have  difficulty  in  getting  anyone  to  identify  him. 
Even  where  the  identifying  party  is  known  to  the  bank  teller, 
it  is  often  necessary  for  such  party  to  have  an  account  with  the 
bank.  Sometimes  such  parties  will  be  asked  to  place  their  en- 
dorsement on  the  check.  It  is  well  nigh  impossible  for  a  per- 
son to  go  into  a  bank  where  he  is  a  stranger  and  get  a  blank 
check.  Every  safeguard  is  thrown  around  the  cashing  of  checks, 
but  with  all,  the  banks  seem  to  stand  in  constant  fear  of  having 
been  victims  of  a  sharp  trick  or  having  paid  the  money  to  the 
wrong  party. 

Even  if  such  were  the  case  the  auditor  would  have  little 
chance  of  discovering  it.  He  is  not  familiar  with  the  signature, 
whereas,  the  paying-teller  is  either  familiar  with  the  signature 
or  knows  that  the  party  to  whom  the  money  was  paid  was  the 
party  whose  name  appeared  on  the  face  of  the  check  and  that 
the  endorsement  on  the  check  is  the  signature  of  that  party. 
The  paying-teller  is  in  a  position  to  take  every  precaution,  but 
the  auditor  has  no  means  whatever  of  discovering  whether  a 
signature  is  good  or  not.  It  may  be  seen  that  the  name  entered 
in  the  cash  book  is  the  same  as  that  which  appears  on  the  face 
of  the  check.  It  may  even  be  seen  further,  that  the  endorse- 
ment on  the  reverse  side  of  the  check  shows  the  same  name  as 
that  appearing  on  the  face  of  the  check,  and  still  there  is  no 
proof  that  the  person  whose  name  appears  on  the  face  of  the 
check  received  the  money.  Even  going  so  far  as  to  grant  that 
the  auditor  might  be  familiar  with  signatures  sufficiently  to  dis- 
cover whether  they  were  genuine  or  forged,  there  is  not  much 
chance  that  the  discovery  of  the  forged  signature  would  be  made 
within  ten  days  after  the  rendering  of  the  account  by  the  bank. 
Tt  is  possible,  of  course,  that  some  auditors  might  take  up  the 
vouching  of  the  cash  immediately  upon  beginning  the  audit,  in 
which  case  a  few  checks  would  probably  come  within  the  ten 
days'  limit. 

If  a  check  is  drawn  to  cash  it  should  be  turned  over  and 
notice  taken  of  who  is  purported,  through  the  endorsement,  to 
have  received  the  money.  Endorsements  will  not  always  be 
found  as  paying-tellers  will  occasionally,  if  they  know  the  party, 
pay  a  check  drawn  to  cash  without  requiring  any  endorsement. 
It  would  seem  well  if  all  paying-tellers  would  require  endorse- 
ments even  on  checks  drawn  to  the  order  of  cash.  The  auditor 

81 


PRINCIPLES  OF  AUDITING 

is  put  on  special  notice  in  examining  checks  drawn  by  executors 
or  trustees,  to  ascertain  through  the  scrutiny  of  the  endorsements, 
who  is  supposed  to  have  received  the  money  on  cash  checks. 
This  matter  of  examining  endorsements  on  checks  drawn  to  the 
order  of  cash  is  one  distinct  from  the  examination  of  the  en- 
dorsements where  a  check  is  drawn  to  order  of  a  specific  party. 
The  auditor  should,  it  seems,  exercise  a  trifle  more  care  in  the 
case  of  cash  checks,  altho  he  will  frequently  discover  that  such 
checks  are  entirely  regular.  A  check  may  be  drawn  to  cash 
and  the  check  cashed  by  some  employe  who  has  charge  of  the 
payroll,  so  that  while  the  practice  is  not  a  good  one  (the  check 
being  preferably  drawn  in  favor  of  the  party  who  gets  the  money), 
everything  is  in  order  so  far  as  the  use  of  the  money  is  concerned. 

A  case  has  recently  come  to  notice  wherein  the  examination 
of  endorsements  would  probably  have  led  to  the  discovery  of 
dishonesty  on  the  part  of  an  employe.  A  certain  association,  one 
of  the  purposes  of  which  was  to  provide  insurance,  employed  an 
adjuster  to  settle  claims.  The  adjuster  was  provided  with  blank 
checks  bearing  the  signature  of  the  proper  official  and  empow- 
ered to  settle  claims  at  such  figures  as  he  could  arrange  with 
the  beneficiaries.  He  was  in  the  habit  of  obtaining,  wherever 
possible,  the  endorsement  of  the  beneficiary  on  the  check  before 
making  the  settlement.  He  then  agreed  with  the  beneficiary  as 
to  the  amount  and  settled  the  claim  in  cash.  He  subsequently 
filled  in  the  check  at  any  amount  which  he  chose,  being  guided 
by  what  would  be  a  reasonable  amount  to  pay  on  each  claim 
and  deposited  the  checks  in  his  personal  bank  account.  Where 
he  was  unable  to  obtain  the  endorsement  of  the  beneficiary  on 
the  check  he  forged  the  endorsement.  It  is  said  in  this  case  that 
the  auditor  did  not  examine  the  endorsement,  failed  to  discover 
the  irregularity,  and  as  the  irregularity  was  discovered  by  rep- 
resentatives of  the  association  soon  after  the  audit  was  com- 
pleted, the  client  refused  to  pay  the  auditor's  fee. 

There  appear  to  be  several  sides  to  this  case.  The  society 
was  undoubtedly  negligent  in  providing  the  adjuster  with  blank 
checks  and  in  allowing  him  to  fix  the  amount  of  the  claim. 
These  two  functions  should  never  be  entrusted  to  one  person, 
namely,  fixing  the  amount  of  the  claim  and  making  the  pay- 
ment. In  the  second  place,  the  bank  seems  to  have  been  negli- 
gent in  allowing  so  many  checks  of  the  association  to  pass  through 

82 


RECONCILING    THE    BANK    ACCOUNT 

the  personal  account  of  a  representative  such  as  this  man  was, 
without  making  inquiry  as  to  the  propriety  of  such  transactions. 
Banks  are  on  notice  to  inquire  as  to  things  of  this  kind,  just 
as  brokers  are  on  notice  to  question  checks  of  executors  or 
administrators  used  by  such  persons  in  stock  trading  transactions 
of  a  personal  nature.  A  certain  firm  of  brokers  was  held  on  a 
deficiency  judgment  not  many  years  ago  for  having  accepted  and 
credited  to  his  individual  account  checks  drawn  by  an  executor 
to  the  brokers'  order.  In  the  case  of  the  adjuster  above  men- 
tioned, the  auditor  was  undoubtedly  negligent  in  that  he  is  said 
to  have  been  informed  before  beginning  the  work  as  to  the 
status  and  authority  of  the  adjuster.  Here  were  special  cir- 
cumstances surrounding  this  case  which  should  have  put  the 
auditor  on  notice.  He  presumably  would  not  have  discovered 
the  forged  signatures,  since  it  is  not  probable  that  the  adjuster 
personally  forged  all  the  endorsement,  or  if  he  did  so,  he  would 
have  seen  to  it  that  there  was  sufficient  variation  in  the  signa- 
tures not  to  attract  attention.  What  the  auditor  would  have 
discovered  was  that  all  these  checks  went  through  the  personal 
account  of  the  adjuster  and  this  should  have  been  cause  for 
concern  and  special  investigation. 

Having  finished  the  vouching  the  reconciliation  may  be  made. 
For  this  purpose  a  sheet  of  journal  paper  will  probably  be  found 
most  convenient.  It  should  be  headed  up  as  usual,  with  the  name 
and  address  of  the  party  whose  accounts  are  being  examined,  and 
should  show  the  name  of  the  bank  in  which  the  account  appears. 
Having  received  the  certificate  from  the  bank  direct  and  not 
through  the  office  of  the  client,  the  statement  may  be  set  up  as 
follows ; 


PRINCIPLES  OF  AUDITING 


—  ^^r^tS  6s7~L*£  / 1-- /  a  f.f  I  a-* 


2gte 


X? 


/       ^ 


Bank  Reconciliation 
84 


RECONCILING    THE    BANK    ACCOUNT 

The  above  reconciliation  is  of  course  a  simple  one.  There 
may  be  at  times  items  of  interest  to  be  taken  into  consideration, 
or  possibly  deposits.  The  principle  involved,  however,  is  shown 
by  the  above  illustration.  There  is  no  reason  for  beginning  with 
the  balance  in  the  bank  and  working  to  the  balance  in  the  cash 
book,  except  that  the  figures  which  the  accountant  will  use  con- 
tinually in  his  working  papers  will  be  those  which  represent  the 
balance  in  the  cash  book.  It  is  easier  in  looking  over  working 
papers  and  in  checking  up  schedules  supporting  the  working 
sheet,  to  have  the  figures  which  are  desired  appear  at  the  bot- 
tom of  the  page  and  to  stand  out  rather  than  to  be  obliged  to 
hunt  over  the  entire  sheet  for  the  figure  which  is  wanted.  The 
balance  which  the  bank  shows  will  almost  invariably  be  different 
from  the  balance  which  the  cash  book  shows.  The  auditor  is 
verifying  the  figures  of  the  client  and  not  the  figures  of  the  bank. 

If  there  are  a  number  of  banks  instead  of  one  as  in  the  illus- 
tration shown,  a  number  of  different  sheets  may  be  used  put- 
ting the  reconciliation  for  each  bank  on  a  separate  sheet  and 
then  preparing  a  recapitulation  sheet  which  will  go  on  the  top 
in  order  to  show  the  total  for  all  banks.  If  the  total  for  each 
bank  is  obtained,  then  the  total  of  all  banks  added  together  should 
prove  the  cash,  provided  all  cash  has  been  deposited. 


CHAPTER    XIII 

VOUCHING  THE  DISBURSEMENTS 

The  disbursements  will,  as  a  rule,  be  supported  by  checks. 
A  check  is  the  best  kind  of  a  receipt.  In  some  instances,  however, 
disbursements  will  be  found  which  are  supported,  in  addition  to 
the  checks,  by  receipts  signed  by  the  parties  receiving  the  money. 
In  some  cases  this  will  be  a  duplication  of  work  so  far  as  the 
bookkeeper  is  concerned,  but  there  will  be  times  when  it  will  be 
found  easier  to  vouch  the  disbursements  from  the  signed  receipts 
than  from  the  checks.  Here,  the  procedure  with  regard  to  the 
vouching  will  be  the  same  as  in  the  case  of  checks,  namely, 
comparing  the  date  of  the  receipt  with  the  date  shown  in  the 
cash  book,  the  name  signed  on  the  receipt  with  that  appearing 
in  the  cash  book  and  the  amount  of  the  receipt  with  that  in  the 
cash  book.  Subsequent  to  these  comparisons  the  receipts  should 
either  be  ticked  or  stamped  with  a  rubber  stamp  as  below : 

EXAMINED 

NEW  YORK  UNIVERSITY 

DIVISION  OF  APPLIED  ACCOUNTING 

The  reason  for  putting  this  stamp  or  tick  on  the  receipts  is  that 
receipts  are  not  apt  to  be  numbered,  they  are  scattered  about  and 
available  for  anyone  who  desires  to  use  them  and  there  is  a 
possibility,  under  such  circumstances,  of  their  being  duplicated. 
Very  often  it  will  be  found  on  examining  the  books  that  there 
will  be  regular  payments  which  will  be  confusing.  Some  party 
will  get  $8.33  every  month,  or  on  the  twentieth  of  every  month, 
and  it  might  be  an  easy  matter  to  present  to  the  auditor  certain 
receipts  of  this  kind  to  support  disbursements  during  the  month 
of  January  and  after  they  had  been  used  by  him  to  take  them 
away  and  return  them  later  as  vouchers  for  the  month  of 
November  or  December.  This  sort  of  irregularity  is  apt  to  exist 
in  connection  with  padded  payrolls.  If  such  receipts  are  stamped 
or  identified  in  some  way  there  is  not  much  likelihood  of  their 
being  used  as  a  voucher  a  second  time.  The  situation  with  the 

86 


VOUCHING  THE  DISBURSEMENTS 

check  is  different.  The  checks  are  numbered  and  the  checks 
presumably  are  controlled  by  a  series  of  numbers.  If  J1253 
has  been  used  once  as  a  voucher,  there  is  not  much  chance  of 
its  going  through  a  second  time  six  months  or  more  later.  If 
an  irregularity  of  this  kind  were  attempted  it  would  undoubtedly 
attract  the  attention  of  the  auditor  immediately.  This  would 
hold  true  even  though  the  amount  happened  to  be  exactly  the 
same  the  second  time.  Of  course,  if  the  auditor  is  not  careful  in 
his  vouching  to  watch  numbers  and  names  as  well  as  amounts, 
such  a  thing  might  happen.  Vouching  of  this  kind  is  a  waste  of 
time  and  unless  the  check  is  properly  examined  and  a  comparison 
made  of  all  the  points  mentioned  the  vouching  may  just  as  well 
be  omitted.  Where  receipts  are  in  a  regular  book  and  numbered 
and  controlled  it  is  not  so  essential  that  they  be  stamped. 

It  is  probable  that  a  word  should  be  said  with  regard  to 
institutions  which  are  run  on  a  cash  basis  and  which  take  no 
cognizance  of  expenses  until  they  have  been  paid  and  make  no 
provision  for  accruals.  Such  institutions,  it  will  be  seen,  would 
have  no  purchase  journal  or  voucher  register  and  no  way  of 
getting  the  distribution,  that  is,  the  charges  to  the  various  ac- 
counts, except  through  the  cash  book.  Such  a  cash  book  as  is 
suggested  is  usually  found  to  be  a  big  cumbersome  columnar 
affair.  In  connection  with  this  cash  book  it  is  customary  to  find 
a  formal  cash  voucher.  It  will  usually  be  a  printed  blank  form. 
The  vouchers  will  be  numbered  in  consecutive  order  with  a 
place  for  the  date,  the  name  of  the  payee,  the  amount  and  the 
description  of  the  purpose  for  which  the  disbursement  is  to  be 
made  and  a  place  for  some  person  or  persons  to  approve  the 
disbursement.  These  vouchers  also  show  the  distribution,  that 
is,  the  accounts  affected.  A  voucher  for  $1,000  may  represent 
charges  to  five  or  six  different  accounts.  If  the  classification 
of  the  accounts  is  very  extensive,  it  will  usually  be  found  on  the 
reverse  side.  Opposite  each  item  in  the  classification  will  be 
shown  the  amount  to  be  charged  to  each  account.  In  such  cases, 
it  should  be  the  auditor's  task  to  run  through  these  different 
accounts,  occasionally  checking  the  distribution  on  the  voucher 
from  supporting  papers  if  there  are  any  and  proving  the  items 
against  the  total.  With  regard  to  the  vouching  the  procedure 
will  be  the  same  as  that  previously  indicated.  Here,  probably  if 
the  vouchers  are  numbered,  it  will  not  be  necessary  to  put  a 

87 


PRINCIPLES  OF   AUDITING 

rubber  stamp  on  them.  On  the  other  hand,  it  will  be  necessary 
or  desirable  at  least,  to  check  the  distribution  in  the  cash  book, 
that  is,  to  see  in  addition  to  checking  the  total  amount  of  the 
disbursement,  that  the  amounts  entered  in  the  respective  columns 
of  the  cash  book  are  the  same  as  the  amounts  indicated  on  the 
voucher  to  be  charged  to  the  respective  accounts. 

The  question  is  frequently  asked,  How  often  should  distribu- 
tion be  checked ;  should  every  voucher  be  examined  for  distribu- 
tion, or  how  many?  There  is  only  one  satisfactory  answer  to 
the  question,  namely,  "if  you  wish  to  be  sure  that  the  distribu- 
tion is  correct,  check  every  voucher."  This  is  as  a  rule  out 
of  the  question  and  the  auditor  will  undoubtedly  have  to  be 
satisfied  with  testing.  He  will  not  generally  be  able  to  go  further 
than  the  arithmetical  accuracy.  He  will  not  be  able  to  decide 
whether  or  not  the  sum  was  disbursed  for  the  purpose  stated  in 
the  voucher  and  which  the  distribution  represents.  Some  officer 
or  representative  of  the  association  will  know,  however,  and 
such  person  should  so  certify  on  the  voucher.  The  auditor  is 
not  required  to  go  back  of  this  certificate  unless  he  has  reason 
to  be  suspicious.  His  duty  seems  to  end  with  a  careful  examina- 
tion of  the  voucher  to  determine  if  it  is  in  order  and  reasonable, 
has  been  properly  approved,  and  is  arithmetically  correct.  He  is 
more  concerned  with  the  total  than  with  the  distribution  and 
it  will  probably  be  sufficient  if  he  tests  the  distribution  on  every 
fifth  voucher.  If  twenty  per  cent  of  the  work,  in  so  far  as  the 
distribution  is  concerned,  is  examined  and  found  correct,  the 
presumption  is  that  there  are  few  mistakes.  Further,  if  the 
work  in  the  cash  book  is  properly  carried  out  by  the  auditor,  a 
somewhat  automatic  check  on  the  distribution  is  obtained,  pro- 
vided the  entries  have  all  been  properly  made.  If  the  distribu- 
tion is  checked  into  the  cash  book  and  the  totals  of  the  distribu- 
tion columns  in  the  cash  book  are  cross- footed  at  the  end  of  the 
month  into  a  total  column,  it  would  seem  to  be  sufficient.  It  is 
possible  that  twenty  per  cent  of  the  distribution  on  a  voucher  is 
not  enough  to  check.  Fifty  or  sixty  per  cent  is  advocated  by 
some  authorities,  the  claim  being  made  that  if  fifty  per  cent  is 
checked,  one  is  sure  that  the  person  who  did  the  work  was 
correct  at  least  half  of  the  time. 

The  footing  of  the  cash  book  is  so  closely  related  to  the 
matters  just  discussed  that  it  is  undoubtedly  appropriate  to  take 

88 


VOUCHING  THE  DISBURSEMENTS 

up  the  question  of  footing  here.  The  auditor  should  foot  the 
net  cash  and  discount  columns  on  both  the  debit  and  credit  sides 
from  the  beginning  of  the  period  to  the  end  of  the  period,  unless 
all  receipts  have  been  deposited  in  the  bank  and  all  disburse- 
ments have  been  made  by  check.  Then,  provided  the  disburse- 
ments have  been  vouched  and  the  bank  account  effectively 
reconciled,  no  footing  need  be  done  in  the  general  cash  book.  In 
order  that  the  reason  for  the  above  rule  may  be  apparent,  the 
following  illustration  is  presented: 


PRINCIPLES  OF  AUDITING 


fc» 


1 


SK 


Si 


90 


VOUCHING  THE  DISBURSEMENTS 

In  this  illustration  there  are  so  few  items  that  it  can  be  seen 
at  a  glance  that  the  balance  as  shown  by  the  tabulation  of  receipts 
and  disbursements  does  not  agree  with  the  balance  as  shown  by 
the  reconciliation.  The  error  is  seen  immediately  to  be  one  in 
the  cash  book.  There  are  five  possible  ways  in  which  the  error 
or  errors  might  have  occurred : 

1.  Some  item  in  the  receipts  incorrectly  entered. 

2.  A  mistake  in  footing  the  receipts. 

3.  Some  item  in  the  disbursements  incorrectly  entered. 

4.  A  mistake  in  footing  the  disbursements. 

5.  An  error  may  have  been  made  in  subtracting  the  disburse- 

ments from  the  receipts  at  the  end  of  some  month  when 
the  cash  book  was  balanced. 

If  all  receipts  were  deposited  and  all  deposits  checked  against 
the  receipts,  the  first  possibility  will  then  be  removed.  This 
would  show  that  all  items  on  the  receipt  side  had  been  correctly 
entered.  There  may  have  been  a  great  many  receipts.  Each 
receipt  may  represent  the  account  of  a  different  customer.  One 
thousand  receipts  may  be  represented  by  one  deposit  in  the  bank 
and  it  is  an  easy  matter  to  list  or  foot  up  the  receipts  from  the 
pass-book  or  from  the  statement  which  the  bank  renders.  This 
may  also  be  done  on  an  adding  machine  and  in  such  manner 
the  footings  may  be  proved.  Thus  the  second  possibility  is 
removed.  In  checking  the  checks  which  have  been  through  the 
bank  and  returned,  against  the  disbursements,  it  will  have  been 
discovered  whether  or  not  an  item  has  been  incorrectly  entered. 
In  taking  off  the  list  of  outstanding  checks  and  deducting  the 
totals  of  this  list  from  the  amount  shown  in  the  certificate,  the 
correctness  or  incorrectness  of  the  vouching  of  the  disburse- 
ments will  be  established.  By  these  two  processes,  possibilities 
number  three  and  number  four  have  been  eliminated.  The 
fifth  is  a  simple  matter  since  there  are  not  likely  to  be  more  than 
twelve  times  in  which  the  balance  in  the  cash  book  has  been 
struck  during  the  year.  Footings  in  a  cash  book  are  usually 
carried  forward  according  to  receipts  and  disbursements  respec- 
tively until  the  end  of  the  month  is  reached,  when  the  balance  is 
ascertained.  Consequently  the  work  of  investigating  the  closing 
figures  in  the  cash  book  at  the  end  of  the  month  is  the  work  of 
only  a  few  moments. 

91 


PRINCIPLES  OF  AUDITING 

If  the  procedure  as  indicated  by  the  rule  has  been  carried  out 
no  footing  need  be  done,  provided  the  bank  balance  has  been 
effectively  reconciled.  If  the  reconciliation  has  not  been  effected, 
comparison  of  receipts  with  deposits  and  disbursements  with 
checks  having  been  made,  the  receipt  side  of  the  cash  book 
should  be  footed  and  a  trial  made  of  the  twelve  monthly  balances. 
This  will  exhaust  all  the  possibilities  except  the  disbursements 
which  it  will  then  be  necessary  to  foot.  The  task  of  footing 
disbursements  may  be  turned  over  to  the  employe  of  the  client 
who  runs  the  cash  book. 

The  auditor  should  discourage  the  practice  of  not  depositing 
all  receipts.  Some  concerns  follow  the  scheme  of  putting  money 
into  a  cash  drawer  while  depositing  all  checks.  Others  draw 
round  amounts  for  payrolls  and  throw  any  unused  portion  in 
the  cash  drawer.  The  practice  of  putting  money  into  a  cash 
drawer,  to  be  paid  out  without  going  through  the  bank  account, 
is,  in  the  opinion  of  the  author,  wrong.  From  the  point  of  view 
of  the  client  it  offers  an  opportunity  to  employes  for  irregulari- 
ties. From  the  point  of  view  of  the  auditor  it  is  undesirable 
since  it  makes  his  task  more  difficult.  Where  this  practice  is 
followed  it  becomes  essential  that  the  cash  book  be  footed.  The 
footing  should  embrace  both  the  debit  and  credit  side  and  extend 
from  the  beginning  of  the  period  to  the  end  of  the  period.  At 
the  end  of  each  month's  business,  as  shown  in  the  cash  book,  the 
cross-footings  should  be  proved. 

The  cash  book  footings  at  the  end  of  each  month  should  be 
checked  with  the  general  ledger.  There  are  four  ways  in  which 
these  postings  may  be  checked.  One  is  to  check  from  the  cash 
book  to  the  ledger;  another  is  to  check  from  the  ledger  to  the 
cash  book.  Still  another  way  is  to  abstract  the  postings  from 
the  cash  book  on  a  separate  sheet  and  check  them  into  the 
ledger.  The  fourth  is  to  abstract  the  ledger  and  check  to  the 
cash  book.  This,  of  course,  applies  to  the  general  monthly  post- 
ings from  the  cash  book  and  not  the  posting  of  details  to  the 
underlying  ledgers. 

A  great  deal  of  discussion  is  frequently  indulged  in  as  to 
whether  the  ledger  should  be  checked  from  the  book  of  original 
entry  or  vice  versa.  That  is  to  say,  should  the  auditor  begin 
with  the  figure  in  the  cash  book  and  trace  it  to  the  ledger,  or 
begin  with  the  figure  in  the  ledger  and  trace  it  to  the  cash  book  ? 

92 


VOUCHING  THE  DISBURSEMENTS 


A  hypothetical  situation  will  perhaps  clear  up  certain  ideas  which 
may  exist  on  this  point. 


JANUARY, 


(Page)  32 


Total 

General 

Expense 

Salaries 

Office  Expense 

1,000.00 

500.00 

300.00 

200.00 

(2Y) 


(76) 


T7S) 


GENERAL  EXPENSE 


(Page) 


1911*-: 

Jan.  131 

c.c.  02:  500:00: 

•         • 
•         • 

In  the  above  illustration  the  bookkeeper,  or  whoever  did  the 
posting,  probably  credited  cash  on  page  twenty-seven  with  $1,000, 
charged  expense  on  page  seventy-four  with  $500,  salaries  on  page 
seventy-six  with  $300  and  office  expense  on  page  seventy-six 
with  $200  and  went  from  the  cash  book  to  the  ledger.  If  the 
auditor  were  to  follow  the  same  order,  it  is  possible  that  he 
might,  if  the  persoa  who  did  the  work  originally  made  a  mistake, 
check  the  mistake.  There  seems  to  be,  on  the  other  hand,  a 
somewhat  greater  chance  of  his  discovering  the  error,  if  in 
checking  he  follows  the  reverse  order.  The  question  does  not 
seem  to  be  an  extremely  important  one,  but  if  there  is  any  choice 
it  is  probably  to  be  given  to  that  procedure  which  checks  the 
postings  in  the  reverse  order. 

A  somewhat  different  and  more  convenient  method  of  check- 
ing postings,  is  to  tabulate  or  abstract  the  postings  on  analysis 
paper  as  they  appear  in  the  illustration  below : 

93 


PRINCIPLES  OF  AUDITING 


Total 

General 
Expenses 

Salaries 

Office 
Expenses 

1914 
January  

$1,000 

$    500 

$300 

$200 

February   

5,000 

4,000 

500 

500 

The  information  concerning  the  months  following  February 
will  be  put  down  as  in  the  case  of  the  months  shown  in  the 
illustration.  It  is  then  an  easy  matter  to  turn,  for  example,  to 
the  general  expense  account  in  the  general  ledger  and  check  the 
twelve  items  one  after  another.  This  would  take  much  less  time 
than  turning  to  the  general  expense  account  on  twelve  different 
occasions  and  checking  one  item  each  time.  This,  it  is  thought, 
will  bring  out  sharply  the  principle  involved  in  the  saving  of 
time  through  the  abstract  of  postings. 

What  is  known  as  abstracting  the  ledger  will  also  offer  the 
same  opportunity  of  facilitating  the  checking  of  postings.  Ab- 
stracting the  ledger  as  commonly  referred  to,  means  going 
through  each  account  and  setting  out  for  instance,  with  regard  to 
cash,  the  debits  and  credits  which  appear  in  the  account.  It 
will  thus  be  seen  that  after  all  the  accounts  in  the  ledger  have 
been  gone  through  in  this  manner,  there  should  be  shown  the 
total  debits  and  credits  of  ,cash  pertaining  to  the  period,  and  the 
respective  totals  of  each  should  agree  with  the  debits  and  credits 
in  the  cash  account  in  the  general  ledger  and  the  cash  book. 
Abstracting  the  ledger  usually  means  following  out  the  procedure 
just  indicated  with  regard  to  all  other  books  of  original  entry 
in  addition  to  the  cash  book.  The  author  once  discovered  a 
$10,000  shortage  by  analyzing  or  abstracting  a  ledger.  The 
practice  should,  however,  be  followed  with  judgment  as  it  con- 
sumes a  great  deal  of  time  as  a  rule. 

With  regard  to  the  checking  of  postings  in  simple  cases,  it 
may  be  said  that  they  may  be  checked  from  the  cash  book  to  the 
ledger,  if  desired.  Where  the  transactions  are  numerous,  the 
volume  of  business  and  the  number  of  postings  large,  they  should 
be  checked  from  the  ledger  to  the  book  of  original  entry.  In 
either  case  the  use  of  the  abstract  of  footings  will  be  entirely 
satisfactory  because  of  the  fact  that  in  so  doing  an  independent 

94 


VOUCHING  THE  DISBURSEMENTS 

posting  medium  will  have  been  raised  and  an  independent  check 
obtained  which  is  likely  to  guard  against  passing  over  errors. 

Detail  postings  where  they  affect  underlying  ledgers  such  as 
creditors  and  customers,  should  be  checked  to  the  extent  probably 
of  fifty  or  sixty  per  cent.  This  may  seem  rather  high  and  will 
perhaps  be  in  some  instances.  The  circumstances  in  each  case 
should  dictate.  The  checking  should  also  be  spread  about.  It  is 
not  desirable  to  take  the  first  month  or  the  last  month,  but  rather 
a  month  here  and  a  month  there,  or  perhaps  every  other  item, 
so  as  to  cover  in  the  checking  as  wide  a  field  as  possible. 

Another  point  which  should  be  mentioned  before  leaving  the 
subject  of  general  cash,  concerns  the  practice  of  holding  the  cash 
book  open  at  the  end  of  the  period  in  order  to  get  in  as  many 
receipts  as  possible.  In  a  case  which  recently  came  to  notice, 
the  fiscal  year  closed  on  September  30.  The  cash  book  was  held 
open  and  there  were  taken  into  the  accounts  for  the  fiscal  year 
ending  September  30,  actual  cash  receipts  up  to  and  including 
October  23.  It  is  important  that  the  auditor  should  watch  mat- 
ters of  this  kind  and  throw  out  both  at  the  beginning  and  the 
end  of  the  period  receipts  or  disbursements  which  do  not  strictly 
apply  thereto. 


95 


CHAPTER   XIV 

THE  PETTY  CASH 

The  auditing  procedure  in  connection  with  the  petty  cash 
may  perhaps  best  be  brought  out  if  discussion  is  first  had  of 
the  two  ways  in  which  petty  cash  accounts  may  be  handled. 

Let  the  illustration  below  represent  a  petty  cash  account  in 
the  general  ledger : 

Petty  Cash 


$50.00 
40.00 
75.00 
30.00 


$42.82 
37.50 
32.43 
76.82 


One  way  of  handling  petty  cash  consists  in  transferring  an 
amount  from  the  general  cash  to  the  petty  cash  and  charging  it 
up  to  the  petty  cash  account  in  the  general  ledger.  The  total 
amount  of  the  disbursements  for  the  month,  for  example,  $42.82, 
becomes  in  effect  the  subject  of  an  original  entry  through  which 
certain  expense  accounts  are  debited  and  petty  cash  is  credited. 
A  further  amount  is  then  transferred  to  the  petty  cash  and 
debited  to  the  account.  This  time  it  may  be  $40  and  further 
amounts  in  subsequent  months  may  be  $75  or  $30,  or  any  amount 
which  it  is  estimated  will  be  needed.  Each  month  in  turn  the 
disbursements  will  be  put  through  on  the  credit  side. 

The  other  way  of  handling  petty  cash  is  to  have  $50,  for 
example,  transferred  to  the  petty  cash  fund  and  charged  up  to 
the  petty  cash  account  in  the  general  ledger.  This  would  appear 
as  below: 


Petty  Cash 


$50.00 


96 


THE    PETTY    CASH 

At  the  end  of  the  month  or  at  any  other  time  convenient,  the 
disbursements  are  totaled  up.  A  voucher  is  then  made  and  a 
re-imbursement  check  to  the  order  of  petty  cash  drawn.  The 
manner  of  handling  the  voucher  will  depend  on  the  system  in  use. 
In  some  cases  where  distribution  is  obtained  through  the  cash 
book,  the  voucher  is  treated  like  any  other  disbursement  and  put 
through  the  cash  book  debiting  the  appropriate  expense  accounts 
through  the  distribution  columns  of  the  cash  book.  In  other 
instances,  where  a  voucher  register  is  operated,  the  regulation 
voucher  is  made  up,  the  expense  accounts  debited  through  the 
distribution  and  accounts  payable  credited.  The  cash  book 
entry  then  debits  accounts  payable  when  credit  is  taken  for  the 
disbursement. 

There  are  two  ways  of  operating  the  general  ledger  account 
even  when  the  amount  of  the  petty  cash  is  fixed.  In  the  first 
way  the  account  is  credited  with  $42.82  when  the  voucher  is 
put  through  and  charged  with  $42.82  when  the  re-imbursement 
check  is  drawn.  This  idea  is  carried  out  from  month  to  month. 
The  second  of  the  two  ways  shows  an  account  for  the  petty 
cash  fund  in  the  general  ledger  which  has  been  charged  with 
$50.  No  other  entry  is  ever  made  in  the  account  unless  the  fund 
has  increased  or  decreased. 

Bookkeepers  very  often  inquire  whether  the  fixed  or  the 
fluctuating  fund  is  the  better.  Also  in  the  case  of  fixed  funds 
whether  the  account  should  show  just  one  debit  and  nothing 
else,  or  whether  subsequent  debits  and  credits  should  be  shown? 
It  is  probable  that  the  fluctuating  fund  is  less  desirable,  not  only 
from  the  point  of  view  of  the  auditor  but  from  that  of  anyone 
else  who  has  to  supervise  the  petty  cash.  This  is  because  it  is 
necessary  to  ascertain  before  a  balance  may  be  checked  how  much 
has  been  received  by  the  person  handling  the  fund.  The  advan- 
tage of  the  fixed  fund  is  the  fact  that  one  is  able  to  tell  by 
looking  at  the  ledger  or  the  trial  balance,  that  the  person  in  charge 
of  the  fund  should  have  a  certain  amount,  say  $50  in  cash  or 
paid  vouchers.  Most  auditors  should,  it  seems,  prefer  the  latter 
method  over  the  first  since  it  facilitates  their  work ;  also  the 
scheme  of  showing  the  subsequent  debit  and  credit  items  even 
though  they  represent  only  disbursements  and  re-imbursements. 
If  the  debit  and  credit  items  are  shown,  one  may  see  at  a  glance 
the  relation  of  the  fund  to  the  disbursements,  which  in  substance 

97 


means  determining  whether  or  not  the  fund  is  adequate.  Further 
than  this,  it  enables  one  to  compare  the  amount  of  the  disburse- 
ments month  by  month.  If  they  run  at  about  the  same  amount 
each  month  and  then  suddenly  rise,  the  fact  is  brought  to  the 
attention  immediately  by  looking  at  the  account.  Where  there  is 
a  summary  and  the  operation  of  the  petty  cash  account  can  be 
seen,  a  historical  record  of  the  transactions  is  afforded.  This 
record  is  sometimes  convenient  since  it  shows  how  much  time 
usually  elapses  between  the  preparation  of  the  voucher  and  the 
re-imbursement  for  same.  This  is  specially  true  in  the  case  of 
branch  offices  where  the  petty  cashier  is  at  some  distance  from 
the  general  office.  The  record  shows  that  the  voucher  was  re- 
ceived on  a  certain  date  and  that  the  re-imbursement  check  was 
issued  on  a  certain  subsequent  date. 

The  auditor  who  is  having  his  experience  of  counting  petty 
cash  for  the  first  time  will  undoubtedly  appreciate  the  advantages 
of  the  fixed  petty  cash  fund.  Where  the  other  method  is  in  use 
he  will  be  obliged  to  get  a  transcript  of  all  the  petty  cash  checks 
which  have  been  issued  to  the  person  in  charge  of  the  petty  cash 
since  the  last  accounting  in  order  to  know  the  total  amount  with 
which  to  charge  him.  As  a  practical  matter  it  is  very  embarrass- 
ing to  skip  an  item  and  perhaps  accuse  a  cashier  of  being  out 
of  balance.  With  the  second  method,  where  the  fund  is  fixed, 
the  chances  are  that  a  mistake  of  this  kind  will  never  be  made. 
The  amount  which  should  be  found  is  ascertained  from  the  post- 
ing of  the  original  entry  in  the  general  ledger  account  and  the 
auditor  may  expect  to  find  cash  or  vouchers  in  that  amount.  If 
the  amount  of  the  original  fund  has  been  increased  or  decreased 
the  ledger  account  will  show  same. 

So  far  as  the  auditing  of  the  petty  cash  is  concerned,  both 
these  methods  must  be  taken  into  consideration  because  of  the 
fact  that  they  are  both  in  general  use.  With  the  first  it  is 
necessary  to  get  a  transcript  from  the  general  ledger  which  will 
perhaps  be  supplemented  by  information  from  the  general  cash 
book.  It  would  not  be  sufficient  to  take  a  transcript  from  the 
general  ledger,  if,  for  example,  the  auditor  were  counting  the 
cash  in  the  middle  of  December.  In  order  to  assure  himself 
that  nothing  had  been  overlooked  it  would  be  necessary  for  him 
to  run  through  the  pages  of  the  general  cash  book  in  order  to 
discover  if  there  were  any  items  which  had  not  been  posted.  In 

9* 


THE   PETTY   CASH 

the  majority  of  cases  probably  postings  to  the  general  ledger 
accounts  are  not  made  oftener  than  once  a  month,  consequently 
care  must  be  exercised  in  cases  of  this  kind  with  regard  to  the 
possible  transactions  between  the  close  of  the  previous  month  and 
the  date  on  which  the  verification  is  being  made.  In  the  second 
case,  reference  must  first  be  had  to  the  general  ledger  in  order 
to  determine  the  amount  of  the  fund.  It  is  also  well  to  ask 
someone  in  authority  if  the  fund  has  been  either  increased  or 
decreased  since  the  close  of  the  last  month. 

So  far  as  the  procedure  on  the  credit  side  of  the  account  is 
concerned,  it  will  be  the  same  in  either  case.  The  auditing  of 
disbursements  is  not  affected  by  the  system.  The  disbursements 
should  be  vouched,  giving  particular  attention  to  the  large  items 
and  using  judgment  as  to  how  much  vouching  it  is  necessary 
to  do.  If  the  petty  cash  disbursements  are  found  to  be  made  up 
of  a  great  many  small  items  and  the  total  amount  involved  is  in 
itself  small,  a  great  deal  of  time  would  be  necessary  in  order  to 
vouch  all  the  items  and  perhaps  the  expense  incurred  greater 
than  the  amount  of  the  petty  cash  disbursements  involved.  It 
would  not  be  good  judgment  under  such  circumstances  to  check 
out  all  the  items.  On  the  other  hand,  if  the  disbursements  run 
into  large  amounts,  it  may  be  thought  necessary  to  vouch  every 
item  and  it  may  be  worth  while  to  do  so.  At  any  rate,  entries 
for  large  amounts  should  be  scrutinized  and  vouchers  for  same 
examined.  It  is  difficult  to  lay  down  any  hard  and  fast  rule  as 
to  the  amount  of  vouching  to  be  done.  The  auditor  must  in  this 
particular  be  guided  by  what  is  necessary  to  satisfy  himself  in 
each  particular  audit. 

Items  will  sometimes  be  found  for  which  no  receipts  or 
vouchers  can  be  produced.  It  is  not  probable  that  where  postage 
stamps  are  purchased  in  small  amounts,  a  receipt  could  be  ob- 
tained from  the  post  office  department.  There  are  other  cases 
where  it  will  not  be  possible  to  get  a  receipt.  Street  car  fare 
and  railroad  fare  and  similar  items  are  as  a  rule  not  supported 
by  vouchers.  Very  often  it  is  necessary  for  the  petty  cashier  to 
take  a  receipt  from  some  person  such  as  an  office  boy  or  mes- 
senger boy  who  pays  out  the  money.  Not  infrequently  entries 
have  to  be  accepted  for  which  there  are  no  vouchers. 

The  distribution  of  any  large  items  should  be  checked,  the 
total  columns  footed,  cross-footings  proved,  the  posting  of  totals 

99 


PRINCIPLES  OF  AUDITING 

checked,  the  balance  in  the  petty  cash  account  agreed  with  the 
count  of  the  cash.  The  balance  should  be  worked  back  to  the 
date  at  the  end  of  the  period  covered  by  the  audit.  The  latter 
will  not  be  necessary  if  there  is  a  fund  in  a  fixed  amount,  since 
such  fund  is  presumed  to  have  existed  at  all  times  in  the  amount 
shown  by  the  ledger. 

It  is  rather  difficult  to  formulate  rules  with  regard  to  petty 
cash  books  because  of  the  fact  that  they  take  so  many  different 
forms.  Sometimes  there  will  be  simply  a  memorandum  book 
without  any  ruling  at  all.  It  is  not  unusual  to  find  a  stenogra- 
pher's note  book  being  used  for  this  purpose.  At  other  times  it 
will  be  a  big  formal  columnar  ruled  book  similar  in  appearance 
to  the  general  cash  book.  There  seems  no  reason  why  it  should 
not  be  ruled  and  ruled  in  columns  so  that  the  distribution  may 
be  made  at  the  same  time  as  the  other  entries.  The  author  once 
ran  across  a  man  keeping  a  petty  cash  account  who  was  a  porter 
and  general  utility  man.  What  he  did  was  to  jot  down  in  a  note 
book  the  amounts  disbursed,  showing  what  they  were  disbursed 
for  and  continuing  this  procedure  for  a  year.  At  the  end  of  the 
year  the  bookkeeper  took  this  book  and  on  a  big  sheet  of  paper 
(not  even  analysis  paper)  headed  up  with  the  various  accounts, 
put  down  the  amounts  under  their  respective  heads  until  all  the 
disbursements  for  the  year  had  been  entered.  Such  procedure 
seems  to  be  rank  waste  of  time.  It  is  just  as  easy  if  distribution 
is  to  be  made,  to  distribute  immediately  after  the  entry  has  been 
made  in  the  total  column,  so  that  when  the  end  of  the  month 
or  the  end  of  the  year  arrives,  the  work  is  completed.  In  one 
case  it  is  ready  when  it  is  needed.  In  the  other  case,  the  work  is 
postponed  and  piled  up  and  when  the  information  is  required  it 
is  not  immediately  available.  It  is  not  improbable  that  the  auditor 
may  do  considerable  missionary  work  in  respect  to  small  matters 
of  this  kind  by  criticizing  in  a  tactful  way  where  work  is  being 
improperly  done  and  offering  suggestions  for  improvement  in 
method  or  system.  The  opinion  is  ventured  that  the  influence  of 
auditors  as  well  as  graduate  students  of  the  subject  of  business 
and  accountancy  has  been  greatly  felt  in  the  business  world  in 
the  past  decade.  Untold  opportunities,  however,  in  this  respect 
still  exist. 

One  other  thought  in  connection  with  the  subject  of  petty 
cash  suggests  itself.  This  concerns  petty  cash  funds  at  branch 

100 


THE    PETTY    CASH 

offices.  In  such  cases  it  is  customary  to  find  monthly  state- 
ments or  reports  sent  in  to  the  head  office.  Just  like  petty  cash 
books,  these  reports  vary  greatly  in  form.  They  depend,  of 
course,  upon  the  system  in  operation.  In  substance  they  are  all 
the  same.  The  information  which  they  show  is  usually  pre- 
sented as  an  account.  The  amounts  received  by  the  branch 
office  appear  on  one  side  of  the  account;  the  disbursements  on 
the  other  side.  The  disbursements  are  usually  accompanied  by 
vouchers.  These  monthly  statements  or  reports  should  be  audited 
just  as  a  person  would  audit  the  petty  cash  book.  This  would 
involve  checking  first  the  balance  brought  forward,  verifying  the 
receipts  from  the  home  office  records,  the  disbursements  from 
the  vouchers,  footing  both  the  debits  and  credits  and  proving 
the  balance. 


101 


CHAPTER   XV 


VOUCHING  THE  PURCHASE  JOURNAL  OR  VOUCHER  REGISTER 

The  title  of  this  chapter  may  raise  a  question  in  some  minds 
as  to  what  difference  there  is  between  the  two  books.  This 
perhaps  is  a  matter  which  belongs  to  accounting  rather  than  to 
auditing  and  may  not  be  entirely  in  place  here.  It  is  not  the 
intention  of  the  author  to  deal  with  the  theory  of  accounting 
nor  with  system  work.  Matters  such  as  pointing  out  the  distinc- 
tion between  these  two  books  seem,  however,  to  warrant  con- 
sideration if  the  proper  foundation  is  to  be  laid  and  the  auditing 
discussion  made  entirely  clear.  The  rulings  for  the  respective 
books  appear  below : 

PURCHASE  JOURNAL 


Total 

DISTRIBUTION 

Heat 

Office 
Expense 

General 
Expense 

Billings  and  Bakner  

$15.00 

$15.00 

VOUCHER  RECORD 


Total 

Date 
Paid 

DISTRIBUTION 

Heat 

Office 
Expense 

General 
Expense 

Billings  and  Bakner  

$15.00 

$15.00 

In  connection  with  the  purchase  journal  there  will  be  ledger 
accounts  such  as  the  one  appearing  below: 

Billings  and  Bakner 


$15.00 


$15.00 


If  a  single  invoice  from  Billings  and  Bakner  in  the  amount 
of  $15.00  might  be  taken  as  an  illustration,  the  procedure  would, 
in  the  operation  of  the  purchase  journal,  be  as  follows :  Invoice 
received,  goods  checked  with  invoice,  price  verified,  extensions 


102 


VOUCHING  THE  PURCHASE  JOURNAL  OR  VOUCHER  REGISTER 

and  footings  checked,  invoice  entered  in  purchase  journal,  show- 
ing the  name  of  the  creditor,  the  total  amount  and  the  distribu- 
tion. At  the  end  of  the  month  the  purchase  journal  should  be 
footed,  the  amount  in  the  total  column  credited  to  accounts 
payable  controlling  account,  the  amounts  in  the  respective  distri- 
bution columns  posted  to  the  appropriate  accounts  in  the  general 
ledger.  The  details  affecting  creditors  would  be  posted  from 
the  purchase  journal  to  the  individual  creditors'  accounts  in  the 
creditors'  ledger.  The  account  used  for  illustration  would  show 
a  credit  of  $15.00  when  this  posting  was  made  and  a  debit  of 
$15.00  when  the  account  was  settled  through  the  payment  of 
cash. 

Where  a  concern  has  sufficient  cash  to  pay  all  accounts 
promptly  and  where  the  total  of  invoices  will  be  paid  at  one 
time  instead  of  paying  something  on  account,  the  bookkeeping 
work  may  be  greatly  reduced  by  eliminating  the  ledger  for  such 
individual  creditors'  accounts  and  combining  the  ledger  and 
journal  function  in  one  book  called  the  voucher  record.  This 
book  is  very  often  known  by  other  names,  such  as  the  voucher 
register,  audited  vouchers,  audited  voucher  record,  etc.  If 
the  journal  function  is  not  altered,  the  entries  are  made  pre- 
cisely as  in  the  case  of  the  purchase  journal  both  with  regard 
to  total  and  distribution.  Instead,  however,  of  opening  a  ledger 
account  with  each  individual  or  creditor  concern,  a  single  line 
in  the  voucher  record  is  used,  namely,  the  line  opposite  the 
creditor's  name  in  the  paid  column,  the  same  thing  is  here  ac- 
complished as  if  the  formal  ledger  account  were  opened.  The 
entry  in  the  total  column  shows  the  credit.  The  date  of  payment 
in  the  paid  column  serves  as  the  debit  and  wipes  out  the  account. 
This  scheme  is  only  workable  where  the  payment  is  in  the  same 
amount  as  the  credit.  Some  variations  of  this  voucher  record 
have  been  seen  where  it  was  the  practice  to  make  payments  on 
account  but  such  schemes  are  not  usually  satisfactory. 

With  the  ordinary  use  of  the  voucher  register  the  invoices  are 
handled  in  about  the  same  way  as  in  the  case  of  the  purchase 
journal  and  the  bookkeeping  procedure  is  also  similar.  Invoices 
instead  of  being  entered  individually  as  in  the  case  of  the  pur- 
chase journal  are  held  in  a  file,  being  sorted  according  to  creditors 
until  a  sufficient  number  have  accumulated,  when  they  are  entered 
on  the  voucher  form,  totaled  up  and  distributed.  The  name  of 

103 


PRINCIPLES  OF  AUDITING 

the  creditor,  total  amount  and  distribution  are  then  entered  in 
the  voucher  register.  In  this  way  only  one  entry  is  made  in  the 
book,  whereas  fifty  entries  might  have  been  necessary  in  the 
purchase  journal.  There  is  no  time  saved  since  the  same  entries 
have  to  be  made  under  either  system  but  where  the  voucher 
register  is  used  they  are  made  on  inexpensive  voucher  forms 
instead  of  filling  up  pages  of  expensive  paper  in  the  books,  which 
pages  have  to  be  footed  and  carried  forward.  There  may  be 
of  course  a  slight  saving  in  this  latter  respect.  Having  entered 
the  vouchers  in  the  record,  the  footings  and  postings  are  made 
in  the  same  way  as  in  the  purchase  journal. 

If  the  above   discussion  has   succeeded   in   establishing  the 
difference  between  the  purchase  journal  and  the  voucher  record, 
attention  may  now  be  given  to  the  matter  of  auditing  in  its  rela- 
tion to  these  records.     It  may  be  remembered  that  in  discussing 
the  mechanical  work,  attention  was  called  to  the  fact  that  it  might 
be  divided  into  three  parts,  namely,  vouching,  footing  and  check- 
ing postings.     The   footing  and  checking  of  postings  will  be 
precisely  the  same  whether  a  purchase  journal  or  voucher  record 
prevails.    The  vouching  is  essentially  the  same  in  both  instances. 
The  method  of  checking,  however,  differs  slightly  in  one  respect. 
In  checking  a  purchase  journal  there  will  be  a  separate  invoice 
for  each  entry  in  the  purchase  journal.     In  the  voucher  record 
the  auditor  will  perhaps,  in  most  instances,  see  at  first  glance 
only  the  voucher.     He  must  bear  in  mind  that  these  vouchers 
are  supported  by  invoices,  and  must  spend  a  certain  amount  of 
time  in  ascertaining  whether  or  not  the  invoices  agree  in  the 
aggregate    with    the    voucher    and    properly    support    it,    and 
further,  whether  or  not  the  invoices  themselves  are  in  proper 
shape.    Having  tested  occasionally,  perhaps  every  fifth  voucher, 
the  make-up  of  same,  that  is,  having  examined  the  invoices  and 
checked  them  with  the  voucher  and  proved  the  footing  on  the 
voucher,  the  following  rules  may  be  laid  down: 

1.  Compare  the  number  of  the  invoice  or  voucher  with  the 

number  in  the  book. 

2.  Compare   the   name   of   the    creditor   on    the    invoice   or 

voucher  with  that  in  the  book. 

3.  Compare  the  amount  on  the  invoice  or  voucher  with  that 

in  the  book. 

104 


VOUCHING  THE  PURCHASE  JOURNAL  OR  VOUCHER  REGISTER 

4.  Tick  the  entry  in  the  book  at  the  right  of  the  figures  in 

the  total  column. 

5.  Stamp  the  invoice  or  voucher  "examined." 

6.  In  the  case  of  every  fifth  voucher  compare  the  distribution 

on  the  voucher  with  the  distribution  in  the  book. 

In  connection  with  this  work  practical  difficulty  will  some- 
times be  encountered.  As  the  vouchers  are  made  out  and  entered 
in  the  voucher  record  they  appear  in  numerical  order.  Once 
they  have  been  entered  they  are  filed  away  as  a  rule  in  alphabetical 
order  because  of  the  fact  that  if  occasion  arises  for  referring 
to  a  voucher,  it  is  something  that  arises  out  of  relations  with  the 
creditor  and  is  apt  to  be  wanted  in  connection  with  the  account 
of  same.  As  a  rule  no  one  except  the  auditor  requires  informa- 
tion concerning  a  voucher  other  than  that  which  arises  out  of 
relations  with  creditors.  If  information  were  wanted  with  regard 
to  Billings  and  Bakner,  it  would  be  most  logical  to  look  for  the 
voucher  in  an  alphabetical  file.  When  the  auditor  comes  to 
check  the  voucher  record  he  finds  that  vouchers  are  scattered  all 
through  the  files,  some  under  A,  some  under  B,  some  under  C 
and  not  at  all  in  the  order  in  which  he  wishes  to  use  them.  Then 
arises  the  question  of  what  shall  be  done.  The  thing  to  be  done 
is  to  go  to  the  client  or  his  representative  who  is  in  authority 
and  state  the  situation.  It  will  take  a  great  deal  longer  if  the 
auditor  is  obliged  to  get  out  these  vouchers  and  arrange  them 
himself  or  check  them  as  they  exist  than  if  someone  else  puts 
them  in  order  for  him.  It  will  probably  cost  five  times  as  much, 
so  far  as  the  auditor's  services  are  concerned,  to  check  the  book 
one  way  as  the  other.  On  this  account  the  question  should,  as  a 
practical  matter,  be  submitted  to  someone  in  authority.  It  will 
usually  be  found  that  the  task  of  putting  them  in  order  will  be 
given  to  some  employe  of  the  client  whose  time  is  not  as  valuable 
as  that  of  the  auditor.  If  the  engagement  has  been  taken  on 
the  contract  basis,  in  which  case  the  person  making  the  estimate 
should  have  taken  such  things  into  consideration,  the  auditor 
will  have  to  use  his  own  judgment  about  asking  for  an  increase 
in  the  fee  unless  he  is  able,  through  tact,  to  succeed  in  having 
some  of  the  clerks  do  the  work  for  him. 

The  total,  and  discount  columns  (trade  discount),  in  case 
the  latter  appears,  should  be  footed  and  the  cross-footings  at  the 

105 


PRINCIPLES  OF  AUDITING 

end  of  each  month  proved.  Postings  of  totals  should  be  checked 
to  the  general  ledger.  For  this  purpose  an  abstract  of  the  post- 
ings will  be  found  very  convenient.  This  way  will  be  found 
especially  advantageous  in  the  case  of  a  voucher  record  where 
the  distribution  is  extensive,  using  sheets  of  analysis  paper  for 
the  purpose  and  if  necessary  pasting  them  together.  These  sheets 
should  be  headed  up  as  usual  and  the  totals  abstracted  by  months. 
If  this  is  done,  one  may  turn  to  any  given  ledger  account  and  the 
entire  twelve  items  or  amounts  checked  at  one  time.  In  the 
case  of  the  purchase  journal  the  individual  items  must  be  checked 
to  the  creditors'  ledger.  In  the  case  of  the  voucher  record,  if 
such  work  has  not  already  been  done,  the  cash  payments  in  the 
paid  column  should  be  checked.  In  connection  with  this  latter 
point,  while  perhaps  this  matter  does  not  come  under  the  head  of 
mechanical  work,  a  list  of  the  outstanding  or  unpaid  items,  some- 
times called  the  open  items,  in  the  voucher  record,  should  be 
made  and  the  total  compared  with  the  credit  balance  in  the 
voucher  record  account  in  the  general  ledger.  This  is  the  same 
thing  as  taking  a  trial  balance  of  the  creditors'  ledger.  If 
there  were  a  ledger  account  for  each  creditor  and  the  credit 
balance  in  each  account  were  to  be  taken  off  and  these  balances 
added  together,  the  total  should  equal  the  amount  in  the  con- 
trolling account  if  the  work  has  been  correctly  done.  Here  the 
open  items  take  the  place  of  the  creditors'  accounts  and  should 
prove  up  with  the  control  in  the  same  way. 

It  is  not  thought  to  be  necessary  to  repeat  the  remarks  con- 
cerning the  procedure,  as  applied  above  to  the  purchase  journal 
and  voucher  record,  in  the  case  of  the  purchase  returns  and 
allowances.  The  voucher  in  the  latter  case  will  be  a  credit 
memorandum  received  from  purchase  creditors. 

While  discussing  the  vouching  of  the  purchase  journal  it 
may  be  desirable  to  include  in  the  discussion,  the  other  books 
which  require  treatment  similar  to  the  purchase  journal.  The 
sales  book,  for  example,  should  be  vouched  from  sales  invoices. 
The  number,  name,  and  amount  on  the  invoice  should  be  com- 
pared with  corresponding  entries  in  the  book.  The  entry  should 
be  ticked  and  the  invoice  marked  "examined."  Distribution 
should  be  occasionally  checked.  The  total  and  discount  columns, 
if  there  are  any  of  the  latter,  should  be  footed.  The  discount 
columns  referred  to  are  those  for  trade  discount  which  are  found 

106 


VOUCHING  THE  PURCHASE  JOURNAL  OR  VOUCHER  REGISTER 

in  some  cases.  Cross-footings  if  they  exist  should  be  proved. 
Postings  of  totals  should  be  checked  to  the  general  ledger,  and 
the  details  to  the  customers'  ledger. 

Sales  returns  and  allowances  may  usually  be  checked  from  a 
carbon  copy  of  the  credit  memorandum.  The  procedure  is  the 
same  as  in  the  case  of  the  sales  book. 

The  payroll  book  should  be  vouched  from  receipts  if  there 
are  any.  The  total  column  should  be  footed  and  the  total  foot- 
ings checked  to  the  general  ledger.  The  distribution  should  be 
checked. 

With  regard  to  the  general  journal,  both  columns  should  be 
footed.  The  postings  should  be  checked  and  any  complicated 
entries  should  not  only  be  scrutinized  but  studied  carefully.  It 
will  be  surprising  at  times  to  find  how  much  light  will  be  thrown 
on  the  situation  if  time  is  taken  to  study  and  understand  what 
appears  at  first  glance  to  be  a  complicated  entry.  The  author  has 
always  contended  that  a  prospective  accountant  who  can  take 
a  series  of  transactions  or  statement  of  facts  and  put  them  into 
the  form  of  a  journal  entry,  has  solved  about  half  of  his  problem. 
A  better  test  of  a  man's  ability  probably  does  not  exist.  If  one 
cannot  state  things  in  terms  of  journal  entry  there  is  not  much 
use  in  trying  to  go  ahead  since  trouble  will  be  sure  to  result. 
Consequently  it  seems  that  if  an  entry  is  found  in  the  journal 
that  is  not  at  first  understood,  it  merits  attention  and  the  auditor 
should  not  drop  it  until  he  is  sure  that  he  understands  it.  There 
is,  of  course,  time  wasted  occasionally  through  stubbornness  on 
the  part  of  the  auditor  in  seeking  to  understand  complicated 
journal  entries  when  he  is  too  proud  to  ask  someone  to  explain 
them.  Care  should  of  course  be  exercised  in  this  respect. 

Included  with  the  above  discussion  might  perhaps  be  the 
mechanical  work  in  connection  with  the  general  ledger.  Such 
work  consists  in  checking  the  balance  brought  forward  from  old 
ledgers  in  case  new  ledgers  have  been  opened ;  footing  the  ledger 
accounts  and  proving  the  balances  if  they  have  not  already  been 
proved  in  taking  off  the  trial  balance. 


107 


CHAPTER   XVI 

INVENTORIES 

Inventories  may  include  materials  and  supplies,  goods  in 
process,  finished  goods,  packing  material,  stock  in  trade,  goods 
in  transit,  goods  out  on  memorandum,  goods  out  on  consign- 
ment, coal,  oil,  waste,  postage,  stationery  and  printing,  and  scrap. 

Inventories  are  of  two  kinds,  book  and  physical.  A  book 
inventory  is  practically  a  trial  balance  of  a  materials  and  sup- 
plies ledger,  or  of  ledger  stock  cards  which  are  frequently  used 
in  connection  with  materials  and  supplies.  There  is  no  reason, 
of  course,  why  the  term  may  not  be  applied  to  any  kind  of  stock, 
for  example,  goods  in  process,  or  finished  goods,  altho  it  is 
most  frequently  used  in  connection  with  materials  and  supplies. 
A  book  inventory  of  goods  in  process,  etc.,  appears  where  there 
is  a  cost  system. 

A  physical  inventory  differs  from  a  book  inventory  in  that 
it  represents  actual  inspection  and  count  of  the  stock  at  a  given 
time.  The  time  is  usually  the  end  of  the  fiscal  year  period, 
altho  the  count  of  certain  articles  may  be  made  at  the  time  during 
the  year  when  the  stock  of  such  articles  is  at  its  lowest  point  in 
order  to  compare  the  count  with  the  book  inventory.  Like  the 
book  inventory  the  physical  inventory  shows  units,  prices, 
amounts  and  total.  In  the  one  case  the  number  of  units  has 
been  obtained  by  actual  count,  whereas  in  the  other  the  figure 
represents  the  balance  which  has  been  obtained  by  keeping  track 
of  the  receipts  and  issues. 

It  may  be  said  that  there  are  five  things  concerning  which 
the  auditor  will  wish  to  satisfy  himself  with  regard  to  the  in- 
ventories. Assuming  that  the  auditor  has  gone  into  the  office 
of  the  client  and  has  had  presented  to  him  a  number  of  sheets 
purporting  to  contain  the  inventories.  The  sheets  will  contain 
a  list  of  articles  showing  in  each  case,  the  number  of  units,  the 
name  of  the  material,  the  price  at  which  the  material  is  carried, 
the  extension  and  the  footings.  In  taking  up  the  work  the 
auditor  will  endeavor  to  satisfy  himself  as  follows : 

First :       That  the  units  of  stock  represented  by  the  inventory 
were  on  hand  at  the  date  thereof. 
108 


INVENTORIES 

Second :  That  the  inventory  contained  no  material  which  was 

obsolete  or  unserviceable. 
Third :     That  the  figures  used  in  pricing  the  inventory  were 

first  correct  and  second,  cost  or  lower. 
Fourth :  That  the  extensions  are  correct. 
Fifth:      That  the  footings  are  correct. 

Taking  these  matters  up  in  turn,  it  appears  first  that  the  in- 
ventory contains  a  statement  to  the  effect  that  there  are  certain 
units  of  stock.  These  units  were  supposed  to  have  been  in  the 
possession  of,  or  owned  by,  the  company  at  the  date  of  the 
inventory.  They  were  supposed  to  have  been  actually  inspected 
and  counted  on  that  date.  In  perhaps  nine  cases  out  of  ten 
the  auditor  was  not  there  in  person  to  inspect  the  articles  and 
see  them  counted.  He  may,  of  course,  take  for  granted  that 
the  inventory  in  this  respect  is  correct.  He  should  not,  how- 
ever, be  satisfied  with  the  fact  that  these  articles  have  been 
put  on  the  list.  He  should  satisfy  and  protect  himself  by  requir- 
ing a  certificate  from  the  person  who  counted  and  recorded  the 
inventory,  or  better,  some  officer  or  reliable  representative  under 
whose  direction  the  inventory  was  taken,  certifying  to  the  fact  that 
all  articles  included  in  the  inventory  were  on  hand  on  the  date 
in  question. 

The  auditor  should  also  ascertain  whether  or  not  the  inventory 
contains  any  old  stock;  stock  for  which  there  is  no  longer  any 
call;  stock  which  cannot  be  sold,  or  at  least  not  sold  except  as 
scrap.  It  very  often  happens  that  there  will  be  around  a  plant, 
old  material,  partially  completed  goods,  and  sometimes  finished 
product,  which  has  little  or  no  value;  certainly  not  a  value  equal 
to  the  cost.  Such  old  material  is  often  carried  year  after  year 
at  cost.  Concerning  this  matter,  the  auditor  may  satisfy  himself 
by  obtaining  a  certificate  to  the  effect  that  the  inventory  contains 
no  such  material,  and  further,  by  making  a  casual  trip  about 
the  plant  and  through  the  stock  rooms,  if  practicable,  and  inquire 
particularly  about  any  unserviceable  material  which  he  may 
observe,  as  to  whether  or  not  it  has  been  included  in  the  inventory. 
This  point  may  raise  a  discussion  at  times  and  perhaps  cause  some 
objection  on  the  part  of  the  client,  if  the  auditor  is  insistent  on 
eliminating  material  which  seems  to  be  unserviceable. 

Not  long  ago  a  case  arose  in  which  an  inventory  contained 

log 


PRINCIPLES  OF  AUDITING 

certain  articles  which  had  been  carried  in  stock  for  almost  ten 
years.  It  was  a  business  in  which  styles  played  an  important  part 
and  the  articles  in  question  had  become  practically  obsolete  be- 
cause of  a  change  in  the  styles.  While  having  had  little  value 
for  practically  ten  years  the  demand  for  goods  in  which  they 
played  an  important  part  having  suddenly  sprung  up  on  account 
of  a  new  style,  these  goods  had  an  inventory  value  on  December 
31,  1914,  of  about  thirty-five  hundred  dollars,  whereas,  a  year 
previous  they  had  scarcely  been  worth,  figuratively  speaking, 
thirty-five  cents.  Through  a  change  in  style,  these  articles  which 
were  as  good  as  new,  not  only  had  an  inventory  value,  but  they 
had  actually  cost  about  fifty  per  cent  less  than  present  market 
prices  when  they  were  purchased.  Similar  cases  are  related 
where  goods  have  been  carried  in  stock  for  a  long  time  at  little 
or  no  value  and  have  suddenly  through  the  European  war  be- 
come much  in  demand  and  consequently  now  have  an  inventory 
value.  Judgment  must,  of  course,  be  exercised  about  things  of 
this  kind. 

The  auditor  should  assure  himself  that  the  prices  are  correct. 
He  should  see  to  it  especially  that  there  has  been  no  mistake  in 
setting  down  the  prices  to  be  used.  Articles  which  should  have 
been  priced  at  one  dollar  and  fifty-four  cents  may  have  been 
priced  at  twenty-seven  cents.  Or  just  the  reverse  may  have 
happened.  Occasionally  prices  become  mixed.  A  concern  may 
have  some  materials  which  are  used  in  small  quantities  but  are 
very  valuable,  whereas,  other  materials  which  are  used  in  large 
quantities  may  be  worth  almost  nothing.  It  is  rather  important 
to  make  sure  that  in  setting  down  such  articles  high  prices  have 
not  been  inadvertently  set  down  against  large  quantities,  and 
low  prices  against  small  quantities.  This  may  occur  without 
any  intention  at  all  on  the  part  of  the  client  or  his  employes  to 
over-value  the  inventory.  It  is  merely  a  clerical  error  which  is 
quite  apt  to  be  made. 

It  is  probably  the  consensus  of  opinion  that  the  inventory 
should  be  priced  at  cost  unless  the  market  is  lower  than  cost,  in 
which  case,  it  should  be  priced  at  the  market.  This  may  perhaps 
seem  inconsistent,  since  it  is  a  difficult  thing  to  get  people  who 
believe  in  cutting  down  the  price  if  the  market  is  lower  than 
cost  to  increase  the  price  if  the  market  is  higher  than  cost.  This 
matter  seems  to  have  two  different  aspects.  One  is  the  effect  on 

no 


INVENTORIES 

subsequent  costs.  The  other  is  the  effect  on  the  financial  condi- 
tion of  the  organization  as  represented  by  the  balance  sheet  and 
taken  in  connection  with  the  replacement  of  the  items.  If,  for 
example,  a  certain  article  is  purchased  at  eighteen  cents  a  pound 
and  the  market  price  goes  down  to  twelve  cents,  a  manufacturer 
is  not  going  to  fool  himself  in  the  next  period,  having  eighteen 
cent  material  on  hand,  by  charging  the  material  into  his  product 
at  twelve  cents.  If  he  has  bought  it  at  eighteen  cents  that  is 
what  the  material  cost  and  that  is  the  price  at  which  the  material 
is  going  to  be  charged  into  the  product  and  the  price  at  which 
it  will  effect  the  cost.  Nothing  would  be  gained  by  withholding 
that  material  and  buying  other  material  at  twelve  cents  so  that 
the  latter  might  be  temporarily  put  into  the  product  in  order  to 
reduce  the  cost.  Sooner  or  later  the  eighteen  cent  material  will 
be  reached  and  will  have  to  be  charged  into  the  product.  Whether 
it  goes  into  the  product  at  eighteen  cents  or  whether  it  goes  in 
at  twelve  cents  while  the  difference  of  six  cents  is  charged  against 
profit  and  loss  makes  little  difference  in  the  effect  upon  the  profits. 
It  seems,  however,  that  so  far  as  charging  the  material  into  the 
product  is  concerned,  it  should  go  in  at  material  cost  regardless 
of  fluctuation  in  the  market. 

There  is,  however,  another  point  of  view  when  the  material  is 
looked  upon  as  an  asset.  A  manufacturer  who  paid  eighteen 
cents  for  certain  material  and  may  now  replace  it  at  twelve  cents 
may,  if  he  desires  to  be  conservative,  carry  it  as  an  asset  in  the 
balance  sheet  at  twelve  cents.  Such  course  is  conservative  and 
no  one  may  reasonably  object  to  that  position  being  taken.  On 
the  other  hand,  a  person  who  accepts  that  theory  will  object  to 
the  product  being  marked  up  if  the  market  has  gone  up. 
Whether  the  market  goes  up  or  down  need  not,  it  seems,  concern 
one.  What  is  on  hand  was  bought  in  a  certain  market  and  at  a 
certain  price.  The  rise  and  fall  in  the  market  does  not  cause  a 
manufacturer  to  rush  in  and  buy  or  sell  for  the  purpose  of  regu- 
lating his  inventory.  He  may  do  so  for  financial  reasons,  which 
is  a  different  matter.  Notwithstanding  all  these  discussions,  as 
has  been  said,  it  is  probably  the  consensus  of  opinion  that  con- 
servative practice  dictates  the  valuation  of  the  inventory  at  cost 
or  less  if  the  market  is  lower  than  cost. 

Where  the  market  is  lower  than  cost  and  it  seems  desirable 
to  adjust  the  inventory  figures  for  balance  sheet  purposes,  such 

III 


PRINCIPLES  OF  AUDITING 

adjustment  may  be  accomplished  through  the  operation  of  a 
reserve.  This  is  preferable  to  actually  adjusting  the  accounts  for 
materials  and  supplies,  since  any  adjustment  of  the  total  figure 
means  an  adjustment  of  the  figures  from  which  the  total 
is  made  up  and  which  may  entail  an  endless  amount  of  work. 
If  the  market  is  lower  on  some  of  the  items  represented  in  the 
controlling  account  the  amount  of  the  inventory  may  be  allowed 
to  stand  in  the  balance  sheet  as  it  was  taken  and  the  extent  to 
which  the  market  is  under  the  cost  in  the  respective  items  may 
be  represented  by  an  estimated  amount  which  may  be  charged 
against  profit  and  loss  and  credited  to  a  reserve.  This  has 
the  effect  in  the  balance  sheet  of  reducing  the  value  of  the 
inventory  without  changing  the  actual  figures  in  the  controlling 
account  and  consequently  not  requiring  any  changes  in  the  figures 
appearing  on  the  subsidiary  stock  or  cost  records.  If,  on  the 
other  hand,  it  ever  becomes  desirable  to  take  cognizance  of  the  rise 
in  the  market,  the  book  figures  need  not  be  changed.  Again, 
an  entry  may  be  made  which  will  increase  the  balance  sheet 
figure  representing  the  materials  and  supplies  and  credit  a  reserve 
for  the  excess  of  market  over  cost.  It  is  possible  that  some  may 
object  to  this  being  done  with  respect  to  the  balance  sheet  and  not 
being  done  on  the  books.  In  such  case  an  entry  might  be  made 
in  the  books  for  closing  purposes  and  reversed  after  closing. 

It  sometimes  becomes  a  part  of  the  auditor's  work  to  be 
present  at  the  time  stock  is  taken,  and  at  other  times  to  suggest 
plans  for  the  taking  of  the  inventory.  It  is  always  much  more 
satisfactory  to  him  when  he  is  present  at  the  time  the  stock  is 
taken,  especially  if  he  is  called  upon  to  give  a  certificate  in 
connection  with  his  audit.  He  may,  however,  be  obliged  to  do 
the  work  at  a  time  which  is  not  as  convenient  personally  as  he 
would  like  to  have  it.  Active  retail  stores  and  hotels,  for 
example,  are  frequently  obliged  to  take  an  inventory  of  stock, 
or  in  the  latter  case,  of  equipment  as  well  as  stock,  at  night. 
The  author  recalls  instances  where  he  was  obliged  to  spend  the 
entire  night  in  observations  of  this  kind.  Mention  is  made  of 
these  matters  in  order  to  bring  to  the  attention  of  a  young  man 
who  aspires  to  enter  the  accounting  profession  the  fact  that  the 
work  is  not  oy  any  means  a  sinecure  and  that  he  must  be  prepared 
to  perform  any  kind  of  service  required  of  him  no  matter  how 
disagreeable  or  inconvenient  it  may  be. 

112 


INVENTORIES 

If  the  auditor  is  not  requested  to  be  present  at  the  taking  of 
the  inventory,  he  may  be  asked  to  submit  a  plan  for  doing  so.  One 
engagement  which  comes  within  the  range  of  the  author's  ex- 
perience may  be  used  to  illustrate  this  point.  A  large  concern 
manufacturing  electric  supplies  requested  a  plan  or  scheme  for 
taking  the  inventory.  The  plan  suggested  contemplated  the  use 
of  slips  made  in  two  parts  and  perforated.  One  part  was  gummed 
and  the  force  which  took  the  inventory  went  through  the  stock 
systematically  making  the  count  and  after  noting  the  count  on 
the  two  parts  of  the  slips,  pasting  the  slips  on  the  boxes  contain- 
ing the  supplies.  A  second  squad  followed,  verified  the  count, 
tore  off  the  perforated  sections  and  initialed  them.  The  slips 
were  subsequently  priced  out,  the  extensions  made  and  the 
record  of  the  inventory  completed.  Where  the  prices  were  the 
same,  slips  were  consolidated  as  far  as  possible  and  then  priced 
out  and  extended  as  already  mentioned.  The  slips  served  as 
vouchers,  as  it  were,  to  support  the  entries.  In  this  case  the 
auditor  had  a  first-hand  voucher  for  the  count  from  someone 
who  had  counted  the  materials  and  supplies.  This,  while  perhaps 
not  as  satisfactory  as  seeing  the  material  counted,  was  probably 
the  next  best  thing.  The  first  count  was  verified  by  a  second 
squad  and  too  many  men  were  involved  to  make  collusion  possible. 

In  taking  inventories  it  is  quite  important  that  boxes  and 
cases  be  opened  and  their  contents  inspected.  If  the  auditor  is 
present  at  the  taking  of  the  inventory  he  is  entitled  to  have  all 
boxes  and  cases  open,  and  should  satisfy  himself  that  he  is  not 
checking  off  empty  containers  as  full  boxes.  While  the  auditor 
has  certain  rights  in  this  respect,  he  must  exercise  some  judg- 
ment and  not  make  unnecessary  work.  If  it  so  happens,  as  it  will 
in  the  majority  of  cases,  that  the  auditor  has  neither  formulated 
a  plan  for  taking  the  inventory  nor  been  present  at  the  time  it 
was  taken,  he  may  accept  a  certificate  concerning  it.  It  is  usually 
customary  where  certificates  of  this  character  are  accepted,  to 
go  into  the  matter  with  the  person  who  is  responsible  for  or 
who  had  charge  of  the  taking  of  the  inventory,  and  ascertain  just 
how  the  stock  was  taken,  how  it  was  priced  out,  the  basis  used 
for  pricing  and  as  much  information  concerning  it  as  possible. 

Another  way  in  which  the  auditor  may  satisfy  himself, 
partially  at  least,  is  through  an  approximation  or  test  more  than 
anything  else  which  consists  in  working  out  the  inventory  from 


PRINCIPLES  OF  AUDITING 

the  cost  of  goods  sold,  which  cost  has  been  obtained  by  using 
the  net  sales  and  gross  profits  on  sales.  As  an  illustration  of 
this,  supposing  the  inventory  at  the  beginning  of  the  period  was 
$10,000  and  the  purchases  during  the  period  were  $25,000,  the 
total  amount  to  be  accounted  for  would  then  be  $35,000.  Assum- 
ing that  the  sales  during  the  period  were  $25,000  and  that  there 
has  been  ascertained  from  the  book  in  the  preceding  period,  or 
from  the  statement  of  income  and  profit  and  loss  of  the  preceding 
period,  that  the  gross  profit  and  loss  was  25%,  meaning  25 %  of 
cost.  The  sales  of  $25,000  would  then  represent  125%  and  the 
cost  of  the  goods  sold  would  be  found  by  dividing  $25,000  by 
125%,  or  $20,000.  By  subtracting  the  cost  of  the  goods  sold 
$20,000,  from  the  previous  figure  of  $35,000  (the  total  to  be 
accounted  for),  the  inventory  on  hand  at  the  end  of  the  period 
should  have  been  $15,000.  This  would,  of  course,  be  an  approxi- 
mation and  would  vary  in  accordance  with  the  fluctuation  in  the 
different  priced  goods.  If  in  this  period  under  review  there 
had  been  a  large  volume  of  sales  of  high  priced  goods  the  calcu- 
lations would  be  affected.  They  would  be  affected  in  the  same 
way  if  there  had  been  a  large  volume  of  sales  of  low  priced 
goods,  because  under  such  circumstances  as  well  as  those  pre- 
ceding the  profit  would  have  been  more  than  or  less  than  25%. 
Since  the  25%  is  an  average  on  everything,  the  result  of  $15,000 
might  be  slightly  inaccurate.  It  would,  however,  it  seems,  be 
sufficiently  accurate  to  serve  a  useful  purpose  since  any  marked 
variation  such  as  a  result  of  $6,000  on  the  inventory  sheets  or 
$27,000,  for  example,  would  be  too  far  off  to  be  allowed  to  pass 
without  attention  having  been  directed  to  the  discrepancy.  The 
figures  used  in  this  illustration  may  have  been  slightly  overdrawn, 
but  the  purpose  was  to  show  how  the  result  of  $15,000  would 
serve  as  a  basis  for  comparison,  offer  an  opportunity  to  investi- 
gate more  thoroughly  and  probably  discover  the  real  trouble. 

Inventories,  when  considered  with  regard  to  prices,  practically 
divide  into  three  groups.  In  the  first  group  may  be  considered 
everything  except  goods  in  process,  finished  goods  and  scrap. 
The  second  group  may  be  said  to  be  represented  by  goods  in 
process  and  finished  goods,  the  third  group  by  scrap. 

With  regard  to  group  one,  the  auditor  should  go  into  the 
question  of  prices  through  reference  to  the  invoices.  It  will  be 
out  of  the  question  to  verify  every  item  on  the  inventory  so  far 

114 


INVENTORIES 

as  prices  are  concerned.  What  should  be  done  is  to  pick  out 
the  most  important  and  higher  priced  articles  and  verify  the 
prices  from  recent  invoices.  The  prices  used  will,  as  a  rule,  be 
found  to  be  those  on  the  invoices  representing  the  last  purchase 
of  goods.  Sometimes  an  average  price  will  be  used  and  some- 
times the  price  will  include  the  allowance  for  inward  freight 
and  cartage.  These  purchase  prices  will  sometimes  be  some- 
what arbitrary  and  at  other  times  the  prices  used  will  be  some- 
what arbitrarily  fixed  by  a  person  whose  judgment  concerning 
prices  is  satisfactory.  In  a  case  of  this  kind  it  is  desirable  that 
such  person  be  asked  to  explain  why  the  price  used  was  selected 
and  why  he  thinks  it  is  a  proper  price  to  be  used.  It  is  very 
largely  a  matter,  so  far  as  the  auditor  is  concerned,  in  a  case  of 
this  kind,  in  deciding  whether  or  not  he  wishes  to  accept  the 
judgment  of  the  man  who  put  the  price  on.  If,  after  talking  the 
matter  over  with  nim,  it  is  thought  that  he  is  consistent,  con- 
servative and  careful  in  fixing  the  price,  the  auditor  may  feel 
satisfied  in  passing  it. 

What  needs  to  be  said  concerning  goods  in  process  applies 
in  a  large  part  to  finished  goods  as  well.  The  problem  is  much 
simplified  if  there  is  a  cost  system.  Reference  to  the  manufactur- 
ing or  cost  ledger  will  show  the  cost  of  the  goods  in  process.  If 
there  is  no  cost  system  an  estimate  will  have  to  be  accepted  and 
the  goods  will  have  to  be  segregated  according  to  departments  or 
according  to  the  various  stages  of  completion  in  which  they  were 
found  at  the  time  the  inventory  was  taken.  The  estimate  should 
include  material  used  in  the  process  of  manufacture  up  to  the 
point  where  the  inventory  was  taken ;  the  same  with  regard  to 
labor  and  a  percentage  added  for  manufacturing  overhead. 

It  would  perhaps  be  somewhat  inconsistent  to  proceed  with 
an  explanation  of  how  to  verify  the  inventory  of  goods  in  process 
without  having  described  the  manner  of  taking  and  pricing 
such  an  inventory.  There  may  be  used  as  an  illustration  of 
such  point,  a  plant  in  which  there  are  eight  departments.  Assum- 
ing, for  example,  that  on  December  31,  the  plant  closed  down 
and  that  the  force  assigned  to  the  taking  of  the  inventory  went 
through  the  various  departments  counting  such  goods  as  were 
actually  found.  From  the  tabulation  which  appears  below  it  will 
be  seen  that  altogether  there  were  two  hundred  units  in  various 
Stages  of  completion.  The  material  unit  cost  is  shown  with 

"5 


PRINCIPLES  OF   AUDITING 

regard  to  each  department;  also  the  cumulative  material  unit 
cost ;  the  departmental  cost  of  the  goods  in  the  various  stages  of 
completion,  as  well  as  the  total  material  cost  of  $1,010.56.  With 
regard  to  labor  there  is  shown  the  departmental  unit  costs,  the 
cumulative  unit  labor  costs  as  well  as  the  cumulative  department 
costs  and  the  total  labor  cost  of  $146.56.  The  way  in  which  the 
overhead  has  been  calculated  will  be  described  later. 

In  order  to  understand  the  situation  better,  it  may  be  advisable 
to  take  up  one  or  two  items  as  shown  in  the  tabulation.  Suppose, 
for  example,  that  the  clerks  working  on  the  inventory,  upon 
arriving  at  department  number  one,  which  represents  the  first 
operation  in  the  process,  find  twenty- four  units  of  goods  partially 
finished  so  far  as  that  department  is  concerned.  If  sharp  lines 
of  demarcation  are  drawn  between  departments  or  operations,  it 
should  be  an  easy  matter  to  determine  the  extent  to  which  material 
has  entered  into  the  product.  The  next  thing  is  to  find  out  how 
much  such  material  costs  per  unit.  This  task  will  be  simplified 
if  there  is  a  cost  system.  If  there  is  no  cost  system,  reference 
may  be  had  to  invoices,  the  material  identified,  the  price  obtained 
and  the  unit  cost  for  the  operation  under  consideration  obtained 
by  a  short  "study."  This  study  would  consist  of  finding  out  how 
much  material  was  necessary  to  turn  out  a  given  number  of 
units,  and  after  getting  the  price  of  the  material  dividing  the 
total  cost  of  same  by  the  number  of  units  produced.  Using 
either  figures  taken  from  the  cost  records  or  the  figures  furnished 
by  the  study  as  a  basis,  the  number  of  units  in  department  No.  1 
(24)  may  then  be  priced  out  at  the  material  cost  of  $1.12, 
amounting  to  $26.88.  The  operation  of  labor  may  be  taken  either 
from  a  bill  of  prices  or  the  cost  records  or  a  study  similar  to  the 
one  just  indicated.  In  department  No.  1,  24  units  at  12  cts. 
per  unit  would  give  the  labor  cost  of  $2.88.  If  each  department 
were  to  be  considered  separately  and  in  the  manner  just  sug- 
gested, the  results  would  be  found  in  the  columns  marked  material 
cost  and  labor  cost  respectively.  The  figures  in  the  column  show- 
ing cumulative  cost  are  the  result  of  building  up  the  unit  costs 
by  departments. 

The  basis  on  which  the  overhead  is  added  is  possibly  more 
scientific  than  those  which  are  frequently  used.  In  the  case 
under  illustration,  since  there  are  eight  departments,  any  goods 
in  department  No.  1  will  be  one-eighth  completed,  and  any 

116 


INVENTORIES 


ifN 
O 


g  u  s  s 

1 1 1 1 


I 

i 


eg  >o 

H   IT 


>0 


117 


PRINCIPLES  OF  AUDITING 

goods  in  department  No.  5  will  be  five-eighths  completed.  If 
these  figures  are  now  reduced  to  a  common  basis  for  the  purpose 
of  getting  an  average,  one-eighth  of  24  will  give  3  as  a  result, 
five-eighths  of  32  gives  20,  six-eighths  of  64-48,  seven-eighths 
of  80-70,  a  total  of  141,  which  divided  by  200,  the  total  number 
of  units,  shows  that  product  taken  as  a  whole  is  70.5%  completed. 
The  prime  cost  is  made  up  of  materials  $1010.56  and  labor 
$146.56.  It  is  found  by  reference  to  the  books  in  the  previous 
period  or  to  statements  which  are  available,  that  the  percentage 
of  manufacturing  overhead  to  prime  cost  in  previous  periods  was 
56.  If  the  same  thing  were  to  hold  true  in  this  period  the  overhead 
would  be  56%  of  $1157.12  (prime  cost)  or  $647.99.  The  total 
inventory  value  of  the  goods  will  thus  be  $1805.11. 

The  overhead  is  many  times  added  through  an  arbitrary 
percentage.  Someone  will  be  of  the  opinion  that  40  or  50  per 
cent,  for  example,  should  be  added  to  cover  the  overhead.  Where 
this  has  occurred  it  is  advisable  to  examine  into  the  basis  sug- 
gested, question  the  person  as  to  the  foundation  for  the  basis 
and  the  reason  for  his  judgment.  If  the  manager  advocates  32 
per  cent  he  should  be  asked  to  explain  why  32  per  cent  has 
been  used. 

From  the  above  discussion  of  goods  in  process  it  will  probably 
be  seen  that  the  rule  to  be  followed  by  the  auditor  consists  in 
ascertaining  with  regard  to  both  goods  in  process  and  finished 
goods  just  what  basis  has  been  used  in  pricing  the  goods,  and 
determining  whether  or  not  such  basis  is  logical.  From  what 
was  explained  in  connection  with  the  goods  in  process,  it  will 
probably  be  possible  to  see  what  should  happen  in  the  case  of 
finished  goods.  It  would  be  a  question  of  getting  all  the  material, 
making  a  test,  or  rather  making  calculations  concerning  the 
material,  labor  and  overhead. 

Scrap  should  be  reduced  to  the  basic  element  or  elements  of 
which  it  is  composed  and  priced  at  the  market  for  same.  The 
tendency  with  regard  to  scrap  is  to  overvalue  it,  so  that  if  any 
considerable  quantity  is  involved  the  auditor  should  be  cautious 
about  accepting  the  values. 

The  auditor  must  also  satisfy  himself  with  regard  to  the 
extensions.  The  larger  items  may  be  tested.  It  is  usually  im- 
possible, from  a  practical  point  of  view,  to  attempt  to  check 
every  item  and  the  extensions  of  all  the  items  in  an  inventory. 

118 


INVENTORIES 

Inventories  are  frequently  very  extensive.  They  sometimes  cover 
hundreds  of  pages.  Again,  in  this  matter  the  auditor  must  ascer- 
tain how  the  extensions  have  been  made.  If  they  have  been 
made  by  hand  and  by  only  one  person,  or  in  other  words,  have 
not  been  checked,  the  extent  to  which  the  auditor  should  go  in 
his  work  would  be  considerably  greater  than  if  the  calculations 
have  been  made  by  a  machine  and  checked.  Many  concerns  now 
have  their  inventories  extended  by  comptometer  operators.  This 
is  not  only  a  means  of  great  relief  to  the  regular  force  but  prac- 
tically insures  the  accuracy  of  the  calculations.  Granting  that 
the  prices  are  properly  set  down,  or  furnished  by  someone  who 
is  accurate,  there  is  little  chance  of  an  ultimate  mistake  existing. 
One  person  makes  the  calculation,  a  second  performs  the  same 
operation,  thereby  checking  the  calculation. 

If  the  inventory  has  been  taken  and  machines  such  as  Hol- 
lerith or  Powers  used  in  getting  the  results,  they  may  usually  be 
accepted  as  being  correct.  If  the  auditor  is  not  satisfied  with  the 
results  he  will  usually  find  that  the  cards  are  available  and  may 
have  them  put  through  the  machine  a  second  time,  thereby  getting 
results  which  may  be  checked  with  those  originally  furnished. 
The  only  possible  mistake  which  may  occur  in  the  use  of  these 
machines  is  in  punching  of  the  cards.  The  chances  of  serious 
errors  are  rather  remote. 

With  regard  to  the  footing,  there  is  not  very  much  to  be  said. 
The  only  way  for  the  auditor  to  satisfy  himself  in  this  respect  is 
to  go  over  the  footings.  If  he  has  neither  the  time  nor  disposi- 
tion to  foot  each  column,  he  may  cast  them  up  roughly  by  glanc- 
ing over  the  figures  in  the  column  and  comparing  them  roughly 
with  the  result.  He  may  of  course  take  them  off  on  an  adding 
machine,  but  this  will  perhaps  consume  as  much  time  as  if  he 
were  to  foot  them  as  they  stand. 

It  may  not  be  out  of  place  to  mention,  in  connection  with  this 
topic,  two  articles  which  appeared  in  the  Journal  of  Accountancy. 
They  are  entitled  "The  Relation  of  the  Auditor  to  Valuation  of 
Inventories,"  by  W.  Ernest  Seatree.  The  first  appeared  in 
the  September,  1914,  number ;  the  second  in  the  November,  1914, 
number. 


119 


CHAPTER   XVII 

ANALYZING  ACCOUNTS 

A  great  deal  of  the  footing  of  the  general  ledger  accounts 
may  be  avoided  if  the  accounts  are  analyzed.  By  analyzing  an 
account  is  meant  taking  it  apart  and  classifying  the  component 
items  so  as  to  get  an  idea  as  to  what  the  account  contains.  It 
will  probably  be  seen  that  if  an  account  is  taken  apart  and  the 
items  are  grouped  according  to  the  different  classes  of  things 
which  they  represent  and  the  totals  of  the  groups  are  added,  a 
proof  on  the  account  will  be  obtained  without  footing  the  items 
as  they  appear  therein. 

Aside  from  proving  the  additions  in  general  ledger  accounts, 
analysis  has  four  practical  objects :  first,  to  see  that  nothing  has 
been  buried;  second,  to  see  that  nothing  has  been  charged  to 
the  wrong  account;  third,  to  see  that  expenses  have  not  been 
capitalized;  fourth,  to  see  that  assets  have  not  been  carelessly 
written  off. 

The  word  "bury"  may  sound  like  slang,  but  it  is  not.  It 
conveys  considerable  meaning  in  accounting.  It  is  almost  a 
technical  term  so  far  as  accounting  is  concerned.  It  means  some- 
thing hidden,  covered  up,  lost  sight  of. 

Again,  something  may  be  charged  to  the  wrong  account 
through  error.  It  may  be  nothing  intentional  on  the  part  of  the 
bookkeeper;  merely  a  mistake  in  getting  it  into  the  wrong  ac- 
count. It  may  occur  because  of  an  error  of  principle;  doing  it 
because  he  does  not  know  any  better,  or  as  a  mechanical  error; 
putting  it  into  one  account  when  he  intended  to  put  it  into 
another. 

Very  often  expenses  will  be  found  charged  to  asset  rvciounts. 
This  has  the  effect  of  capitalizing  them.  Such  is  more  apt  to 
be  the  case  where  a  concern  is  running  behind;  the  profits  are 
not  as  large  as  they  have  been,  or  it  was  hoped  they  would  be; 
or  there  is  an  operating  contract  with  the  manager  or  superintend- 
ent whose  compensation  depends  upon  the  profits.  There  is 
always  more  or  less  of  a  struggle  going  on  between  the  adminis- 
tration and  the  management.  The  manager  is  inclined  to  attempt 
to  capitalize  everything  possible  in  order  to  keep  down  the  ex- 

121 


PRINCIPLES  OF   AUDITING 

penses  and  increase  the  profits.  The  administration,  on  the  other 
hand,  is  exercising  vigilance  constantly  in  order  to  prevent  the 
capitalization  of  expense. 

Concerning  the  fourth  class,  there  is  a  tendency  on  the  part 
of  many  concerns  and  individuals  to  write  off  promiscuously 
thoroughly  good  assets  because  there  is  in  their  opinion  some 
question  about  when  or  how  they  will  be  used  up.  Such  concerns 
or  individuals  are  anxious  that  nothing  shall  appear  in  the  list 
of  assets  which  is  not  absolutely  sound  and  has  a  "convertible 
value,"  as  it  is  sometimes  expressed.  Anything  like  chairs  or 
small  fixtures  that  are  liable  to  become  broken,  lost  or  stolen, 
are  in  such  cases  charged  immediately  to  expense  without  any 
consideration.  Frequently  these  things  are  carried  to  extremes, 
sometimes  intentionally  and  sometimes  ignorantly.  In  a  recent 
case  which  came  to  attention,  several  thousand  dollars  worth 
of  furniture  was  charged  to  expense  when  purchased  because 
it  was  argued  that  the  furniture  would  wear  out  in  a  short 
time,  the  concern  could  afford  it  and  therefore  it  was  the  easiest 
way  of  disposing  of  the  matter.  Such  argument  and  procedure 
may  be  quite  proper  but  it  appears  to  open  the  way  and  make 
easy,  crookedness  where  it  might  not  otherwise  appear.  If 
employes  know  that  things  of  such  character  are  charged  off 
and  lost  sight  of,  there  is  no  reason  why  they  may  not  help 
themselves  to  things  which  may  be  carried  away,  especially  if 
no  record  of  such  articles  is  kept. 

The  four  things  above  mentioned  would  not  be  brought  to 
the  attention  simply  through  the  mechanical  work  of  checking. 
Checking  would  not  disclose  anything  buried.  It  is  not  prob- 
able that  it  would  disclose  anything  charged  to  the  wrong  ac- 
count. There  may  be,  however,  an  exception  to  this  statement. 
If,  for  example,  the  bookkeeper  is  posting  to  the  furniture  and 

Pxtnres  account  and  such  account  in  the  ledger  appears  on 
age  54,  he  may  inadvertently  turn  to  page  56,  there  make  the 
posting  and  note  the  posting  reference  in  the  appropriate  column 
in  the  voucher  record  as  page  56.  The  item  has  obviously  been 
posted  to  the  wrong  account.  It  will  be  found  on  page  56  of 
the  ledger  and  56  will  be  marked  on  the  voucher  record,  so 
that  whether  the  auditor  checks  from  the  voucher  record  to 
the  ledger  or  from  the  ledger  to  the  voucher  record  he  will  find 
an  entirely  good  posting  from  page  56  and  the  opinion  may 

122 


ANALYZING    ACCOUNTS 

be  ventured  that  in  many  cases  the  mechanical  checking  would 
not  disclose  the  error.  If  perchance  the  bookkeeper  notes  in 
his  voucher  record  54  as  the  page  to  which  he  intends  to  post 
the  item  and  then  posts  it  to  page  56,  such  an  error  would  un- 
doubtedly be  caught  in  checking.  This  illustration  of  course 
raises  a  question  with  regard  to  the  technique  of  checking,  as 
to  whether  or  not  the  auditor  in  checking  should  observe  the 
title  of  the  account  affected  rather  than  the  pages.  It  is  of 
course  true  that  the  ideal  manner  of  checking  is  one  which  takes 
into  consideration  the  accounts  affected  as  well  as  the  amounts. 
The  page  numbers  theoretically  serve  only  as  a  means  of  assist- 
ance in  finding  the  proper  accounts.  Practically,  when  a  person 
settles  down  to  the  humdrum  of  checking,  the  page  numbers 
are  probably  more  apt  to  serve  as  a  guide  to  the  amounts  only 
rather  than  the  titles.  While  this  argument  of  course  departs 
from  the  ideal  it  recognizes  the  weakness  of  human  nature 
when  involved  in  work  of  this  kind.  It  requires  an  unusual 
man  to  glorify  work  of  this  nature  to  the  point  where  every  bit 
of  it  will  be  done  thoughtfully.  Many  begin  this  work  with 
good  intentions.  It  is  safe  to  say  that  most  of  these  fall  into 
the  same  rut  and  after  a  short  space  of  time  has  elapsed  do  this 
work  in  the  same  old  mechanical  way.  It  is  more  apt  to  be 
done  well  if  done  by  two  persons  rather  than  one,  since  one 
calls  and  the  other  checks. 

Analyzing  accounts  is  a  part  of  the  work  which  may  not  be 
too  carefully  done.  Above  all  the  results  must  be  comprehensive 
and  clearly  expressed.  The  amount  of  time  involved  in  making 
an  analysis  is  usually  considerable.  If  the  results  when  obtained 
are  not  clear  and  understandable  and  do  not  permit  of  use  the 
time  has  been  wasted. 

It  may  be  interesting  to  have  the  procedure  involved  in 
analysis  given  first,  to  be  followed  by  a  typical  case  which  will 
be  worked  out. 

Analysis  paper  should  be  used.  It  should  be  headed  up  with 
the  name  of  the  organization,  the  period  covered  by  the  work 
and  a  statement  to  the  effect  that  it  is  an  analysis  of  such  and 
such  an  account.  One  sheet  (or  more  if  necessary)  should  be 
used  for  the  debits  and  one  sheet  or  more  for  the  credits  unless 
it  is  quite  obvious  that  both  debits  and  credits  will  go  on  one 
sheet.  One  may  frequently  be  deceived  about  this  and  it  is 

123 


PRINCIPLES  OF   AUDITING 


probably  safer  always  to  take  a  separate  sheet  for  debits  and 
credits.  Beginning  in  the  upper  left-hand  corner  in  the  first 
column,  the  date  should  be  provided  for ;  in  subsequent  columns 
the  posting  references  and  amounts.  After  the  amount  there 
should  be  noted  any  explanation  which  may  appear  in  the  ledger 
account. 

In  the  illustration  about  to  be  presented  especially  the  tran- 
script of  the  ledger  account  and  the  analysis,  it  should  be  remem- 
bered that  one  is  not  asked  to  pass  on  the  propriety  of  the  account 
or  the  items  therein  but  rather  to  observe  the  technique  involved 
in  analyzing  the  account.  The  ledger  account  is  first  presented 
as  below  in  order  that  each  step  in  the  process  from  beginning 
to  end  may  be  observed. 


JL..,..: 


£~L 

!>*-./ 


Assuming  now  that  a  sheet  of  analysis  paper  has  been  headed 
up,  starting  in  the  upper  left-hand  corner,  a  transcript  of  the 
ledger  account  should  be  made.  In  this  case  one  sheet  of  analysis 
paper  will  suffice,  since  the  debits  and  credits  will  all  go  on  one 
page.  Reference  to  the  illustration  which  appears  below  will 
show  the  first  three  columns  devoted  to  the  dates,  references 

124 


ANALYZING    ACCOUNTS 


125 


PRINCIPLES  OF   AUDITING 

and  amounts.  It  should  also  be  noted  that  care  has  been  ob- 
served in  stating  not  only  the  total  debits  and  the  total  credits, 
but  in  showing  clearly  the  balance  in  the  account  as  it  appeared 
in  the  ledger  account. 

Little  matters  like  bringing  the  balance  out  clearly  as  above 
mentioned  may  not  seem  important.  When  the  time  comes, 
however,  to  use  the  figures  it  may  be  long  after  the  analysis 
is  made.  Little  points  like  properly  bringing  out  the  balance  in 
the  ledger  account  may  either  greatly  facilitate  or  hinder  the 
work  at  the  time  the  figures  are  "put  together."  Not  long  ago 
in  going  over  a  report  a  skeleton  ledger  account  appeared  to 
show  a  balance  of  $45,000.  The  books  from  which  the  figures 
were  taken  were  not  available  and  it  was  necessary  to  take 
off  a  trial  balance  of  the  skeleton  ledger  which  had  been  built 
up  from  the  cash  book  before  being  able  to  tell  whether  the 
account  should  show  a  balance  or  not.  Half  an  hour  of  the 
time  of  a  busy  man  who  was  engaged  in  writing  comments  was 
required  in  taking  off  the  trial  balance  of  the  skeleton  ledger 
in  order  to  determine  whether  the  balance  of  $45,000  was  open 
or  not  When  upon  completing  the  work  it  was  found  that  the 
debits  exceeded  the  credits  in  the  amount  of  $45,000,  the  con- 
clusion was  that  the  account  had  been  closed.  This  expense 
of  time  and  annoyance  was  caused  by  careless  work  on  the  part 
of  an  assistant  who  did  not  realize  the  importance  of  careful 
attention  to  details.  In  just  such  ways  as  this,  hours  of  time 
are  wasted  by  accountants.  The  man  who  put  the  figures  to- 
gether in  a  report  wants  to  be  sure  when  he  picks  up  an  analy- 
sis that  he  is  using  the  proper  figures.  He  must  know  that 
the  figures  are  the  same  as  those  in  the  books ;  that  the  difference 
between  the  debits  and  credits  which  he  is  using  is  the  same 
balance  as  that  for  the  particular  account  in  question  in  the 
trial  balance. 

Assuming,  now  that  the  transcript  of  the  ledger  account  has 
been  properly  made  on  the  analysis  paper,  the  next  step  is  to 
find  out  what  each  one  of  the  items  represented  therein  means. 
Explanations  of  postings  sometimes  appear  in  ledger  accounts. 
In  such  cases  they  should  be  jotted  down  when  making  the 
transcript,  but  should  serve  only  to  indicate  the  content  of  the 
account.  It  is  probable  that  the  tendency  to-day  is  away  from 
showing  explanations  in  the  ledger.  Sometimes  in  simple  ac- 

126 


ANALYZING    ACCOUNTS 

counts  it  is  practicable  to  give  complete  explanations  for  each 
item.  Usually,  however,  the  postings  are  made  at  the  end  of 
the  month  and  may  represent  a  considerable  number  of  items 
and  variety  of  things.  It  is  of  course  ideal  when  the  complete 
story  contained  in  an  account  may  be  read  from  the  explana- 
tion columns.  It  will  probably  be  an  exceptional  case,  how- 
ever, where  this  will  be  possible.  In  the  transcript  of  the  ac- 
count appearing  above  the  first  item  appearing  is  the  balance 
in  the  ledger  account  for  furniture  and  fixtures.  In  a  property 
account  such  as  the  furniture  and  fixtures  account  is  the  bal- 
ance should  be  traced  back  into  previous  ledgers  if  possible 
and  analyzed.  On  the  first  engagement  this  is  essential.  On 
subsequent  engagements  it  need  not  be  done  of  course. 

Taking  up  next  the  second  item  of  $257.50  it  will  be  neces- 
sary to  find  out  what  this  amount  represents.  Assuming  there 
is  no  information  on  the  face  of  the  ledger,  which  at  best  would 
serve  only  as  a  guide,  it  will  be  necessary  to  go  back  to  the 
book  from  which  the  entry  was  made.  The  book  in  this  case 
is  the  voucher  record,  page  27.  The  term  voucher  record  is 
used  here  as  synonymous  with  the  purchase  journal.  Turning 
to  page  27  of  the  voucher  record  it  will  be  found  that  this  page 
shows  the  footings  for  the  month  of  January  where  the  book 
will  probably  have  been  ruled  off  and  the  totals  for  the  month 
of  January  inserted.  Hunting  out  the  column  for  furniture  and 
fixtures,  if  there  is  one,  there  will  be  found  at  the  bottom  of 
the  column  the  amount  of  $257.50.  Tracing  up  the  column 
there  will  be  found  on  a  certain  line  the  same  item  of  $257.50. 
Following  then  across  the  page  to  the  left  on  this  line  the 
voucher  number  will  be  discovered.  It  will  next  be  necessary 
probably  to  "pull  the  voucher"  as  it  is  called,  or  have  the  voucher 
"pulled."  Usually  a  list  of  the  vouchers  that  are  wanted  is 
given  to  the  bookkeeper  or  clerk  who  has  charge  of  them  and 
the  vouchers  are  gotten  out.  Having  obtained  the  voucher  in 
the  amount  of  $257.50,  it  may  be  found  upon  examination  to 
represent  the  purchase  of  desks  and  chairs.  The  next  step 
consists  in  noting  on  the  analysis  sheet  to  the  right  of  the  amount 
— $257.50,  the  explanation,  namely,  "desks  and  chairs"  together 
with  the  voucher  number,  for  example,  233. 

In  certain  instances  items  for  furniture  and  fixtures,  for 
example,  will  occur  so  infrequently  that  it  will  not  be  thought 

127 


PRINCIPLES  OF  AUDITING 

necessary  to  provide  a  column  for  these  items.  If  this  is  the 
case,  it  would  be  necessary  to  hunt  through  the  general  ledger 
column  in  the  voucher  records  and  pick  out  the  items  represent- 
ing furniture  and  fixtures. 

The  next  item  of  $300  will  be  found  on  page  32  of  the 
voucher  record.  This  will  be  the  footing  for  February,  and 
finding  the  column  for  furniture  and  fixtures  it  may  be  followed 
up  until  the  first  item  is  found.  It  is  possible  a  better  way 
would  be  to  turn  back  to  the  beginning  of  the  month  and  hav- 
ing found  the  furniture  and  fixtures  column,  follow  it  down 
until  the  first  item  is  reached.  In  this  case  the  first  item  may 
be  found  to  be  voucher  No.  273,  which  upon  inspection  will 
show  that  the  amount  covered  a  bulletin  board — $25.  Continuing 
on  down  the  column  the  next  voucher  may  be  No.  286  and 
will  be  found  to  represent  more  desks  and  chairs  in  the  amount 
of  $275.  This  information  may  then  be  carried  to  the  analysis 
sheet  and  jotted  down  in  the  appropriate  place.  Subsequent 
items  as  they  appear  in  the  ledger  account  will  be  found  ex- 
plained on  the  analysis  sheet.  It  is  not  thought  necessary  to 
follow  through  the  procedure  in  each  case,  since  it  has  in  two 
instances  been  explained  and  illustrated.  Up  to  this  point  it 
will  be  noted  that  no  consideration  has  been  given  to  the  content 
of  the  account  whether  right  or  wrong.  The  work  has  consisted 
entirely  of  noting  facts. 

On  one  of  the  sheets  of  analysis  paper,  if  more  than  one  is 
used,  and  preferably  the  top  sheet,  there  will  usually  be  room 
at  one  side  where  a  summary  of  the  analysis  may  be  made.  This 
is  necessary  in  order  that  one  may  look  at  the  analysis  and  see 
at  a  glance  what  the  account  contains  without  having  to  go 
through  it  item  by  item.  The  summary  will  be  found  in  this 
instance  on  the  analysis  sheet.  Where  the  account  is  extensive 
and  a  number  of  pages  are  required  for  the  items,  or  where 
the  summary  is  extensive,  the  summary  should  be  placed  on  a 
separate  sheet  which  will  go  on  top  of  the  others  where  it  may 
be  readily  seen. 

The  information  concerning  the  furniture  and  fixtures  account 
is  now  in  such  condition  that  when  the  time  for  preparing  the 
reports  arrives,  one  may  see  at  a  glance  what  is  in  the  account. 
This  person  may  be  the  one  who  made  the  analysis  or  some- 
one else.  The  information  contained  in  the  summary  may  be 
scrutinized  and  discussed  with  regard  to  the  propriety  of  the 

128 


ANALYZING    ACCOUNTS 

entries  and  the  propriety  of  the  items  with  special  reference  to 
discovering  whether  anything  has  been  buried,  charged  to  the 
wrong  account,  expenses  capitalized  or  assets  carelessly  written 
off.  A  person  looking  at  this  summary  has  the  story  of  the 
account  before  him  in  crystallized  form.  It  would  be  appro- 
prLte  at  this  time  to  consider  whether  or  not  the  old  desk  sold 
for  $25  should  be  credited  to  this  account  in  the  amount  of  $25 ; 
also  whether  the  amount  representing  branch  office  furniture  de- 
stroyed by  fire  is  on  the  basis  of  cost  or  the  amount  in  which 
the  claim  against  the  insurance  company  was  settled.  With 
regard  to  depreciation,  the  value  of  the  summary  might  have 
been  enhanced  somewhat  if  the  man  who  made  it  had  shown 
the  basis  on  which  the  depreciation  was  calculated.  With  ref- 
erence to  this  particular  analysis  it  would  appear  that  everything 
in  the  account  is  regular,  that  there  is  nothing  out  of  propor- 
tion and  nothing  to  attract  undue  attention  or  cause  undue 
investigation. 

In  order  to  check  the  figure  for  depreciation,  an  analysis 
of  the  balance  at  the  beginning  of  the  period  would  have  to  be 
made  unless  this  had  been  done  in  a  previous  audit  and  the 
information  was  available.  The  depreciation  it  will  probably  be 
seen  is  based  not  only  on  furniture  and  fixtures  purchased  dur- 
ing the  present  year  but  that  which  came  over  from  a  previous 
period.  Time  being  an  element  in  the  calculation  of  depreciation, 
the  length  of  time  which  the  respective  articles  of  furniture  have 
been  in  use  will  have  to  be  ascertained.  This  work  may  some- 
times be  facilitated  by  an  underlying  book  kept  by  the  client  in 
which  the  details  of  property  accounts  are  shown.  If  no  such 
book  is  kept  it  is  probable  that  the  bookkeeper  or  company 
accountant  will  have  retained  the  figures  on  which  the  calculation 
was  based. 

In  the  matter  of  analysis  the  question  which  frequently  arises, 
is  how  many  and  which  accounts  should  be  analyzed.  In  answer 
to  that  question  it  must  be  said  that  it  is  not  considered  necessary 
nor  is  it  customary  to  analyze  all  the  accounts.  This  work 
should  be  applied  particularly  to  the  property  accounts  and  ex- 
pense accounts  of  any  size.  Irregularities  are  more  apt  to  be 
found  in  property  accounts  and  in  expense  accounts  than  in 
others.  The  other  accounts,  at  least  most  of  them,  will  be  checked 
out  automatically  in  the  course  of  the  work. 

129 


CHAPTER   XVIII 

SOME  ACCOUNTS  WHICH   REQUIRE  ANALYSIS 

After  the  work  on  the  inventories  has  been  completed  the 
trial  balance  should  be  gone  over,  account  by  account,  analyzing 
or  checking  up  such  accounts  as  need  attention.  If  reference 
is  made  to  the  specimen  trial  balance  previously  presented,  the 
first  account  will  be  seen  to  be  land  and  buildings. 

The  land  and  buildings  account  should  be  analyzed.  This 
should  be  done  not  only  on  account  of  the  four  usual  reasons 
for  analysis  but  also  to  determine  how  much  of  the  account  rep- 
resents land  and  how  much  buildings.  It  is  frequently  desirable 
to  have  this  information  in  order  to  determine  whether  or  not 
the  insurance  is  adequate.  In  a  mixed  account  like  land  and 
buildings  it  is  impossible  to  form  any  judgment  on  this  point 
unless  the  two  factors  in  the  account  are  separated.  An  account 
for  land  and  buildings  as  it  appears  on  the  books  may  show  a 
balance  of  $187,000.  It  may  also  be  ascertained  that  insurance 
is  being  carried  to  the  extent  of  $80,000.  Before  one  can  say 
definitely  whether  or  not  $80,000  is  adequate,  the  extent  to 
which  buildings  are  represented  in  the  $187,000  must  be  known. 
It  is  likewise  necessary  to  have  information  on  buildings  in  order 
to  calculate  or  check  the  depreciation. 

The  analysis  of  the  land  and  buildings  account  should  show 
with  regard  to  land,  the  purchase  price  of  the  original  parcel 
plus  any  improvements,  such  as  filling  in,  grading,  laying  out 
streets,  curbing,  guttering,  laying  of  sidewalks,  setting  out  trees, 
etc.  There  should  also  be  shown,  the  sales  of  any  part  of  the 
land,  and  the  auditor  should  ascertain  whether  any  credit  repre- 
senting a  sale  is  on  a  cost  or  selling  price  basis.  It  not  infre- 
quently happens  that  when  land  is  sold  the  selling  price  is  credited 
to  the  land  and  buildings,  or  the  land  account,  as  the  case  may  be. 
Since  the  selling  price  includes  the  profit  such  procedure  is  doubly 
detrimental.  It  not  only  fails  to  show  the  profit  but  it  has  the 
effect  of  applying  the  profit  to  the  reduction  of  the  asset.  What 
should  be  done,  of  course,  is  to  find  out  in  terms  of  square  feet 
of  acres,  how  much  land  was  purchased  and  obtain  the  cost  per 
square  foot  or  acre.  If  any  part  of  the  land  is  sold  the  number 

130 


SOME  ACCOUNTS  WHICH  REQUIRE  ANALYSIS 

of  square  feet  or  acres  should  at  cost  be  credited  to  the  land 
account  while  the  difference  is  credited  to  profit  and  loss  or  to 
surplus. 

A  request  should  be  made  to  see  the  deed  to  the  property 
and  the  title  insurance  policies.  This  is  also  as  good  a  time  as 
any  to  ask  for  the  tax  receipts.  It  is  also  well  to  note  on  the 
working  papers  showing  the  analysis  of  the  account,  the  fact 
that  the  deed,  title  insurance  policies  and  tax  receipts  have  been 
seen.  Taxes  should  be  distinguished  from  assessments.  Taxes 
may  not  be  capitalized  and  should  not  appear  in  the  land  ac- 
count, whereas  assessments  may  with  propriety  so  appear.  As- 
sessments may  cover  such  things  as  removing  cobblestones  and 
replacing  them  with  modern  paving,  putting  in  sewers  or  water 
systems  and  the  like.  All  these  things  constitute  improvements 
to  the  property  and  may  be  charged  to  the  land  and  buildings 
account.  In  New  York  City  assessments  are  being  laid  for  cer- 
tain branches  of  the  subway  system  and  there  is  probably  no 
doubt  about  the  propriety  of  capitalizing  such  assessment  since 
the  property  along  the  subway  routes  will  benefit  accordingly. 

An  interesting  problem  with  regard  to  assessments  recently 
came  to  notice.  A  certain  institution  had  during  a  period  extend- 
ing as  far  back  as  1868  sustained  assessments  which  amounted 
to  $30,000.  The  institution  had  been  contending  against  these 
assessments  on  the  ground  that  it  should  be  exempt  under  cer- 
tain privileges  which  the  law  extends  to  educational,  religious 
and  other  eleemosynary  corporations.  The  efforts  to  have  these 
assessments  abated  not  having  been  successful  the  institution 
put  the  claims  into  the  hands  of  a  lawyer  who  makes  a  specialty 
of  getting  abatements,  with  the  understanding  that  if  he  suc- 
ceeded in  this  case  he  should  receive  ten  per  cent.  The  lawyer 
was  successful  and  earned  $3,000.  The  question  which  was 
presented  to  the  author  was  this,  "Shall  we  capitalize  the  $3,000 
or  charge  it  to  expense."  The  question  is  undoubtedly  a  trying 
one.  The  assessments  if  sustained  would  have  constituted  a 
bona  fide  addition  to  the  cost  of  property.  On  the  other  hand, 
the  services  of  the  lawyer  were  without  question  expense.  The 
expense,  however,  was  incurred  in  saving  a  capital  disburse- 
ment of  $30,000  and  consequently  takes  on  a  capital  appear- 
ance. The  solution  which  was  suggested  was  in  the  nature  of  a 
compromise.  While  perhaps  not  so  stated  by  the  institution  it 


PRINCIPLES  OF  AUDITING 

was  apparent  that  one  of  the  principal  points  of  objection  was 
the  necessity  of  including  an  item  of  $3,000  in  the  operations  of 
one  year,  while  the  expenses  were  in  connection  with  having 
assessments  abated  which  extended  back  forty-five  years.  The 
suggestion  was  therefore  made  that  the  amount  cf  $3,000  be  set 
up  on  the  books  and  written  off  over  a  period  of  ten  years. 

The  other  part  of  the  land  and  buildings  account  about  which 
nothing  has  yet  been  said  is  that  representing  the  buildings. 
This  should  consider  the  original  purchase  price  of  the  build- 
ings plus  any  additions  or  betterments.  In  lieu  of  the  purchase 
price  there  may  appear  payments  on  account  of  building  con- 
tracts. The  account  may  also  show  credits  for  sales  of  parts 
of  the  buildings  and  possibly  credits  for  depreciation.  It  is  of 
course  important  to  be  on  the  lookout  for  repairs  which  have 
been  capitalized. 

Regarding  the  insurance  on  buildings  the  auditor  should  bear 
in  mind  that  unless  property  is  insured  for  eighty  per  cent  of 
its  value,  the  holder  of  the  policy  becomes  a  co-insurer  to  the 
extent  of  the  difference  between  eighty  per  cent  of  the  value 
and  the  amount  at  which  the  property  is  insured.  There  are 
different  kinds  of  policies  and  of  course  policies  in  which  full 
value  is  received  in  case  of  a  total  loss.  For  such  policies  an 
increased  premium  is  paid.  It  is  probable,  however,  that  the 
majority  of  policies  are  written  with  what  is  called  the  eighty 
per  cent  clause.  While  it  would  seem  that  all  owners  of  prop- 
erty should  be  familiar  with  matters  of  this  kind  it  sometimes 
happens  that  they  are  not. 

In  a  number  of  accounts  which  follow  it  is  not  thought  nec- 
essary to  go  into  all  the  details  concerning  them.  The  pro- 
cedure laid  down  in  the  preceding  chapter  together  with  the 
explanation  in  connection  with  land  and  buildings  should,  it 
seems,  serve  sufficiently  as  a  guide.  The  other  property  accounts 
especially,  are  the  same  in  their  nature  as  the  land  and  buildings 
account  and  may  generally  be  treated  in  the  same  way. 

The  account  for  machinery  and  tools  should  be  analyzed 
and  inquiry  made  as  to  whether  or  not  the  account  contains 
items  of  such  equipment  which  are  obsolete;  also  the  extent 
to  which  the  account  represents  small  tools  which  are  subject  to 
loss  or  destruction,  in  order  to  compare  the  book  value  of  such 
tools  with  the  physical  inventory  of  same. 

132 


SOME  ACCOUNTS  WHICH  REQUIRE  ANALYSIS 

Another  account  which  should  be  included  in  the  work  of 
analysis  is  the  account  for  horses,  wagons  and  motors.  It  seems 
almost  unnecessary  to  say  that  the  analysis  should  show  the 
component  parts  of  the  account,  that  is  to  say,  how  much  repre- 
sents horses,  wagons  and  motors  respectively.  Where  the  units 
of  equipment  are  so  easily  separable  on  account  of  their  size 
an  attempt  should  be  made  to  identify  the  equipment  by  units 
and  make  it  possible  to  compare  the  physical  property  with  the 
book  record.  It  is  also  important  that  the  date  of  purchase  of 
these  units  should  be  carefully  set  out  so  that  depreciation  may 
be  calculated  or  checked. 

Furniture  and  fixtures  should  be  analyzed.  More  difficulty 
will  probably  be  experienced  in  connection  with  this  account 
than  in  any  other  in  identifying  the  units.  While  it  is  true  that 
the  units  may  be  fairly  large  it  is  not  probable  that  the  book 
records  will  enable  one  to  distinguish  between  expensive  and 
inexpensive  units. 

Securities  owned  may  next  be  taken  up.  The  extent  to  which 
the  account  represents  stocks,  bonds,  bonds  and  mortgages  and 
miscellaneous  securities  should  be  ascertained.  In  many  instances 
provision  for  this  separation  will  be  made  in  the  ledger  by  keep- 
ing the  respective  accounts  and  the  title  "securities  owned"  will 
only  be  used  in  the  balance  sheet.  It  is  quite  usual,  however, 
to  find  all  securities  appearing  in  one  general  ledger  account. 
It  is  to  be  presumed,  of  course,  that  the  securities  were  examined 
and  listed  at  the  time  the  audit  was  begun  so  that  at  this  point 
after  having  ascertained  the  aggregate  of  the  respective  factors 
in  the  account  the  result  of  the  count  should  be  compared  thereto 
class  by  class.  At  this  time  there  should  also  be  covered  the 
matter  of  checking  up  verifications  which  have  come  in  as  a 
result  of  requests  sent  out  at  the  beginning  of  the  audit  on  ac- 
count of  securities  which  may  have  been  out  for  various  pur- 
poses, such  as  collateral,  etc.  The  question  of  valuation  is  not 
one  which  arises  at  this  time.  It  should  be  taken  up  rather  at 
the  time  of  preparing  the  balance  sheet  and  writing  the  comments. 

Treasury  stock,  if  such  an  account  appears,  should  be  looked 
into  with  the  view  of  ascertaining  just  what  the  conditions  sur- 
rounding the  account  really  are.  The  thing  to  be  determined 
is  whether  or  not  something  so-called  is  treasury  stock.  The 
discussion  with  regard  to  this  matter  will  depend  upon  the  theory 

133 


ntiff aruE*  or  AWWTWG 

which  the  auditor  hold*  concerning  treasury  stock.  Whether 
or  not  k  hti  been  properly  handled  on  die  books  in  question  win 
be  determined  by  the  auditor  through  a  comparison  of  the  man- 
ner in  which  it  has  been  handled  with  his  own  idea  as  to  how 
it  ihould  have  been  handled  Since  there  are  conflicting 
theories  on  this  point  it  behooves  the  auditor  to  make  very  sure 

I  ground  on  which  he  argues.  The  suggestion  is  made  that 
there  is  but  one  safe  theory  concerning  treasury  stock.  Stock 

'•i  has  been  once  issued  for  value  and  subsequently  acquired 
should  be  so  considered.  Stock  which  has  not  been  issued  should 
never,  in  the  opinion  of  the  author,  be  considered  as  treasury 
Hock 

Patents,  trade-marks,  copyrights  and  good-will  may  all  be 
included  in  one  account.  Again  the  discussion  as  to  whether 
or  not  they  have  been  properly  handled  will  depend  upon  the 
theory  which  the  auditor  holds  concerning  each  item.  The 
account  ihould  be  analyzed  in  order  that  there  may  be  set  forth 
the  amount  representing  patents,  trade-marks,  copyrights  and 
good-will,  respectively.  Wrong  treatment  is  perhaps  of  no 
more  importance  than  the  fact  that  they  have  all  been  thrown 
in  together.  The  auditor  should  know  the  period  for  which 
the  |MI.  ni  ..  hade  marld  or  COpyrightl  arc  issued  and  be  guided 
accordingly  in  deciding  whether  or  not  such  items  have  been 
'landU-d.  There  arc  so  many  conflicting  theories  con- 
cerning good-will  that  it  does  not  seem  wise  to  lay  down  any 
rule  for  same.  Having  analyzed  the  account  and  found  out 
the  amount  \\liirh  n-pivM-nts  ^ood-vvill  one  must  be  guided  by 
the  circumstances  in  the  case  and  decide  whether  or  not  the 
manner  in  which  the  good-will  has  been  treated  is  logical  and 
•\v.  Information  will  sometimes  be  found  in  the  rec- 
ords, or  in  the  minutes,  or  some  contract  which  will  satisfy  one 
as  to  the  figure  at  which  the  good-will  is  carried.  This  may 
at  times  be  supplemented  by  the  opinion  of  some  official  who  is 
qualified  to  pass  judgment  on  the  matter  or  to  explain  the  basis 
upon  which  the  value  was  set  up. 


134 


CHAPTER   XIX 

THE  CUSTOMEES'  LEDGES. 

The  auditor  may  either  take  a  trial  balance  of  the  customers' 
ledger  or  check  the  one  furnished.  In  the  majority  of  cases  it 
is  probable  that  the  trial  balance  of  the  customers'  ledger  will 
be  furnished.  It  is  also  probable  that  in  most  cases  the  auditor 
will  check  the  one  furnished  rather  than  take  off  his  own.  Noth- 
ing seems  to  be  gained  by  making  a  new  trial  balance.  Such 
procedure  was  advocated  in  the  case  of  the  general  ledger  be- 
cause the  time  consumed  in  so  doing  offered  an  opportunity  to 
study  the  business.  The  situation  with  regard  to  customers' 
accounts  is  different.  One  customer's  account  is  like  every  other 
customer's  account  in  its  relation  to  the  organization,  conse- 
quently no  benefit  seems  to  be  derived  from  taking  off  a  new 
trial  balance.  On  the  other  hand,  a  great  deal  of  time  is  saved, 
especially  if  the  accounts  are  numerous,  in  using  the  one  furnished. 

The  information  being  sought  with  regard  to  the  customers' 
accounts  is  whether  or  not  the  ledger  containing  the  details  is 
in  agreement  with  the  controlling  account  and  whether  or  not 
the  accounts  are  worth  their  face  value.  On  the  first  point  the 
auditor  may  assure  himself  by  taking  or  checking  the  trial  bal- 
ance of  the  customers'  ledger.  The  determination  of  the  sec- 
ond point  is  somewhat  more  difficult.  In  order  to  assure  him- 
self concerning  this  matter  he  must  endeavor  to  ascertain  whether 
or  not  the  indebtedness  as  shown  is  admitted  by  the  customer 
as  being  correct  and  get  the  opinion  of  someone  qualified  to 
judge  as  to  whether  or  not  the  amounts  shown  will  be  collectible 
in  full 

In  order  to  determine  whether  or  not  the  indebtedness  as 
shown  is  bona  fide  and  correct,  it  is  customary  to  send  out  some 
communication  to  the  customer  and  obtain  his  acknowledgment 
as  to  the  balance.  This  may  be  done  in  one  of  several  ways. 
One  way  is  to  have  the  monthly  statements  turned  over  to  the 
auditor  to  be  checked  by  him  and  sent  out  direct.  It  is  impor- 
tant that  the  statements  should  not  fall  into  the  hands  of  the 
employes  of  the  client  before  being  sent  out  but  should  be  in- 
serted in  the  envelopes  and  sealed  immediately  after  being  checked 

135 


PRINCIPLES  OF  AUDITING 

It  is  also  important  that  upon  their  return  statements  should 
reach  the  auditor  without  being  opened.  This  is  sometimes 
accomplished  by  having  the  statements  mailed  to  the  auditor's 
business  office.  Objection  to  this  procedure  is  sometimes  made 
by  the  client  in  that  it  draws  attention  to  the  fact  that  his 
accounts  are  being  audited.  This,  in  the  light  of  present-day 
publicity,  does  not  seem  to  constitute  a  valid  objection.  It  is, 
however,  an  objection  which  it  is  not  always  possible  to  over- 
come even  with  tact  and  has  to  be  endured.  Where  such  is  the 
case  the  auditor  is  usually  able  to  arrange  to  have  such  state- 
ments returned  in  envelopes  which  may  be  identified  and  which 
will  be  presented  to  him  immediately  they  are  received  in  the 
client's  office. 

It  is  customary  for  the  auditor  to  have  affixed  to  statements 
before  they  are  sent  out,  a  notice  of  some  kind,  to  the  effect 
that  the  information  is  required  for  the  purpose  of  verifying 
the  balance.  The  content  of  the  notice  which  is  usually  affixed 
by  means  of  a  rubber  stamp  takes  two  forms.  One  is  that  of  a 
positive  verification.  The  other  is  that  of  a  negative  verifica- 
tion. These  verifications  are  in  substance  as  they  appear  below : 


Please  verify  the  above  balance  and  report  at  your 
earliest  convenience  to  John  R.  Wildman,  Certified 
Public  Accountant,  32  Waverly  Place,  New  York 
City. 


Please  examine  immediately.  If  not  correct,  please 
address  New  York  University,  Division  of  Applied 
Accounting,  Washington  Square  East,  New  York, 
stating  difference. 


Another  method  of  obtaining  verifications  is  to  send  out 
with  the  statement  a  form  letter  with  a  perforated  form  attached, 
requesting  the  customer  to  verify  the  balance  and  report  on  the 
blank  form  provided.  A  specimen  of  this  form  as  used  by  Haskins 
and  Sells  follows. 


THE   CUSTOMERS     LEDGER 


W.TCRTOWN  HASKINS    &    SELLS 

rnVsaoBGH  eMTiriio  PUSLIC  ACCCOUHTANT* 

CLEVELAND  30     BROAD    STRUT 

CH.CAOO^  Ntw  VORK 

ATLANTA  CMU  «to.n.  ••HAIKICU3" 

DCNVCR 

•AN    rKANCI»CO 

LONDON,  t.  C. 


DEAK  SIK: 

'  In  connection  with  our  audit  of  the  books  and  accounts  »< 
we  are  sending  herewith  their  statement  of  your  account  with  them  covering  the  inclusive   period  from 

,     ,  and  shall  be  obliged  if  you  will  examine  it  and  advise  UK 

on  the  attached  form  of  Us  correctness  or  of  any  exception  you  may  find  to  take  thereto. 
Stamprd  and  addiessed  envelope  for  your  reply  is  enclosed! 

Yours  truly, 


No,. 


MESSRS.  HASKINS  &  SELLS, 

Certified  Public  Acctmittaitli 

DEAR  SIRS  : 

I  have  examined  the  statement  received  from  you  of  my  account  with. 

covering  the  inclusive  period  from _________________^_^_ 

find  it* 


Yours  truly. 


•Ituert  the  word  "Correct "  U  yon  10  find  the  (Utcment. 


All  of  these  devices  are  at  best  unsatisfactory.  It  is  a  diffi- 
cult matter  to  obtain  verifications  of  all  balances.  It  is  probably 
within  reason  to  say  that  at  least  one-third  of  the  customers 
will  pay  no  attention  to  the  request,  thereby  making  a  complete 
verification  impossible.  The  larger  balances  should  be  followed 
up  with  a  second  or  third  request  if  necessary.  The  positive 

137 


PRINCIPLES  OF  AUDITING 

verification  seems  preferable  to  the  negative.  The  latter,  how- 
ever, does  place  the  burden  on  the  customer  and  results  in  a 
considerable  saving  in  time  in  so  far  as  the  auditor  is  concerned. 

In  the  matter  of  satisfying  himself  with  regard  to  the  prob- 
ability of  collection  of  the  accounts  the  auditor  is  usually 
compelled  to  rely  on  the  judgment  of  the  credit  man  or  some 
representative  of  the  client  who  is  in  a  position  to  state  as  a 
result  of  his  experience  with  the  concern  whether  or  not  the 
respective  accounts  will  be  collected.  In  accomplishing  this  the 
auditor  goes  over  the  accounts  one  by  one  with  the  credit  man, 
for  example,  who  gives  his  opinion  with  regard  to  each  account 
as  to  whether  it  is  good,  doubtful  or  uncollectible.  By  classify- 
ing the  individual  accounts  in  this  way  the  auditor  is  enabled 
to  ascertain  with  regard  to  the  accounts  as  a  whole  the  extent 
to  which  they  are  respectively  good,  doubtful,  or  bad.  In  case 
there  is  no  credit  department  there  will  usually  be  found  in  the 
employ  of  the  client  someone  who  will  perform  this  function  of 
the  credit  man. 

A  valuable  means  of  supplementing  the  opinion  of  the  credit 
man,  which  it  must  be  said  is  not  always  as  unbiased  as  it  might 
be,  consists  in  aging  the  accounts.  This  lakes  the  form  of 
analyzing  each  balance  or  determining  with  regard  to  the  bal- 
ance in  the  account  how  long  it  has  been  outstanding,  and  classi- 
fying the  balance  with  regard  to  the  length  of  time  it  has  been 
outstanding.  In  some  cases  the  time  may  be  classified  as  thirty 
days  or  less,  sixty  days  or  less  or  more  than  sixty  days.  Circum- 
stances in  different  cases  will  of  course  dictate  different  periods 
of  time.  If  goods  in  a  particular  case  are  sold  on  a  six  months' 
basis,  the  thing  of  interest  is  to  find  out  how  many  of  the  accounts 
are  over  six  months  old.  In  such  a  case  the  periods  of  time 
might  be  six  months,  nine  months  and  a  year. 

Aging  the  accounts  is  an  expedient  which  is  especially  help- 
ful to  the  auditor  in  enabling  him  to  judge  independently  as  to 
the  value  of  the  accounts  receivable  and  the  adequacy  of  the 
reserve  for  bad  and  doubtful  accounts.  If  an  account  which 
should  have  been  settled  within  thirty  days  has  been  outstanding 
two  or  three  years,  the  chances  are  that  said  account  is  not  a 
perfectly  good  account  even  though  so  considered  by  the  credit 
man.  Some  credit  men  are  capable  and  honest  and  give  an 
absolutely  unbiased  opinion.  Others,  while  honest,  may  not 

138 


THE   CUSTOMERS'   LEDGER 

have  all  the  facts  as  to  the  accounts,  or  may  fear  to  give  a 
frank  opinion  concerning  certain  accounts  because  of  the  un- 
favorable showing  which  may  result.  Credit  men  have  been 
known  to  classify  certain  accounts  as  good  when  the  concerns 
in  question  were  in  the  hands  of  receivers  and  there  was  no 
probability  that  more  than  ten  per  cent  of  the  amount  involved, 
for  example,  would  be  received.  Having  aged  the  accounts  the 
auditor  is  not  obliged  to  rely  on  such  opinions.  He  has  a 
definite  basis  for  his  own  judgment. 

In  order  to  make  clear  what  is  meant  by  aging  the  accounts 
an  illustration  is  presented  below.  There  is  first  given  an  out- 
line of  the  schedule,  followed  by  a  number  of  customers'  ledger 
accounts.  The  schedule  should  be  made  on  analysis  paper,  pro- 
viding for  the  ledger  folio,  name  of  the  customer,  amount  and 
classification  according  to  the  periods  of  time. 

Trial  Balance,  Customers'  Ledger,  December  31,  1914 


L.F. 

Name 

Amount 

30  days     60  daj 

Over 
60  days 

Sheldon  &  Willis 

1913 

1914 

Nov.  13,        S—  32          $47.50 
Dec.  8,          S—  47             18.37 
1914 

Jan'y  4,          C—  2             $47.50 
March  25,      C—  18            18.37 

March  28,     S—  84 
July  14,         S—  122 

52.74 
15.96 

(68.70) 


$134.57 


Clarkson  &  Company 


$65.87 


1914 

1914 

Oct.  14, 

S—  173 

$15.43 

Nov.  2, 

C—  27 

$15.43 

Nov.  24, 

S—  185 

5.81 

Dec.  5, 

C—  32 

5.81 

Dec.  13, 

S—  194 

4.62 

$25.86 

$21.24 

(4.62) 

139 


PRINCIPLES  OF  AUDITING 

S.  Merrick 

1914 

1914 

Jan'y  1. 

Bal. 

$753.27 

Feb.  2, 

C—  10 

$27.45 

"  31, 

S—  52 

27.45 

June  9, 

C—  21 

425.00 

June  7 

S—  115 

225.00 

Oct.  5, 

C—  25 

172.43 

Oct.  5, 

S—  170 

172.43 

$1,178.15 

$624.88 

(553.27) 

Hoyt  &  Stetson 

1914 

1914 

Aug.  3, 

S—  151 

$31.86 

Aug.  27, 

C—  20 

$29.43 

Sept.  17, 

S—  165 

16.52 

Oct.  5, 

C—  24 

16.52 

Oct.  14, 

S—  173 

19.43 

Oct.  29, 

C—  25 

19.43 

Nov.  29, 

S—  187 

27.18 

Dec.  4, 

C—  32 

27.18 

Dec.  15 

S—  195 

15.75 

Dec.  24, 

C—  34 

15.75 

(2.43) 


$110.74 


$108.31 


In  the  accounts  as  they  appear  above  the  first  one  is  that  of 
Sheldon  &  Willis.  It  shows  debits  in  the  amount  of  $134.57; 
credits  $65.87;  balance  $68.70.  Assuming  that  the  date  at  the 
end  of  the  period  covered  by  the  audit  is  December  31,  1914, 
if  an  attempt  is  made  to  classify  the  balance  with  regard  to  age, 
it  will  be  seen  that  it  is  over  sixty  days.  The  first  entry  may 
now  be  made  in  the  schedule  showing  ledger  folio  $1 — Sheldon 
&  Willis — $68.70,  the  latter  to  be  entered  first  in  the  amount 
column  and  subsequently  in  that  marked  "over  60  days."  If 
the  same  procedure  is  followed  in  the  case  of  the  other  accounts 
the  schedule  will  then  appear  as  below. 

Trial  Balance,  Customers'  Ledger,  December  31,  1914 


L.F. 

Name 

Amount 

30  days 

60  days 

Over 

60  days 

1 
2 
3 

Sheldon  &  Willis 
Clarkson  &  Co.  .  . 
S.  Merrick  

$68.70 
4.62 

553.27 

$4.62 

$68.70 
553.27 

4 

Hoyt  &  Stetson  .  . 

2.43 

2.43 

, 

$629.02 

$4.62 

$624.40 

140 


THE   CUSTOMERS     LEDGER 

The  study  of  customers'  accounts  is  a  very  interesting-  one. 
They  will  at  times  reveal  a  great  deal.  That  of  S.  Merrick  as 
presented  above  illustrates  one  point  in  this  connection.  The 
account  is  shown  as  having  an  old  balance,  just  how  old  of  course 
is  not  disclosed.  Notwithstanding  this  balance  more  goods  were 
sold  to  him  on  January  31  which  it  will  be  seen  he  paid  for  very 
soon.  On  June  7  still  more  goods  were  sold  to  this  party.  He 
not  only  paid  for  the  invoice  of  June  7  but  included  in  his  check 
something  to  apply  on  the  old  balance.  The  story  told  by  this 
account  is  that  of  an  old  balance  being  reduced.  It  is  a  hopeful 
sign  and  indicates  good  intentions  on  the  part  of  the  customer. 
Consequently  with  indications  of  this  kind  one  should  be  cautious 
about  classifying  the  account  as  doubtful. 

It  is  well  that  all  transactions  of  every  description  should  be 
put  through  a  customers'  account.  Sometimes  in  the  case  of  a 
customer,  such  as  Merrick  appears  from  the  account  to  have 
been,  checks  will  be  received  for  current  invoices  which  when 
presented  for  collection  are  returned  marked  "no  funds."  In  a 
case  of  this  kind  the  check  should  be  charged  back  to  the  ac- 
count so  that  the  account  will  show  the  full  history  of  the  cus- 
tomers' relations  to  the  house.  This  would  also  call  for  a  record 
of  any  notes  which  went  through  the  account  and  which  should 
be  charged  back  to  the  account  if  not  paid  at  maturity.  It  also 
seems  desirable  that  a  notation  should  be  made  at  the  top  of  each 
account  of  the  number  and  amount  of  customer's  notes  which 
are  being  carried  since  it  is  the  credit  relation  which  is  usually 
desired  in  connection  with  a  customer.  Whether  this  is  repre- 
sented by  accounts  or  notes  is  not  so  important  as  to  know  the 
total  amount  of  indebtedness.  It  is  also  desirable  to  have  such 
information  all  in  one  place. 

In  the  case  of  Hoyt  &  Stetson  it  will  be  seen  that  the  balance 
of  $2.43  is  an  old  one.  The  indications  are  that  it  is  a  disputed 
claim.  In  a  case  like  this  whether  it  be  over  sixty  days  or  over  a 
year  makes  little  difference.  The  important  thing  which  is  brought 
out  is  the  fact  that  the  item  is  in  dispute.  An  opportunity  is 
thus  afforded  to  investigate  the  matter  and  have  it  adjusted  in 
some  way.  Such  is  one  of  the  additional  advantages  of  aging 
the  accounts,  namely,  the  bringing  to  the  surface  of  all  differences 
which  require  adjustment  and  which  are  frequently  allowed  by 
bookkeepers  to  drag  on  indefinitely  when  they  should  be  closed  out. 


Drafts  and  notes  receivable  come  under  this  heading.  A  list 
of  these  will  probably  have  been  made  at  the  time  when  they 
were  counted  or  examined.  If  this  has  not  been  done,  a  list 
should  be  made.  The  total  of  such  count  or  list  should  agree 
with  the  balance  in  the  ledger.  Cognizance  will  have  to  be  taken 
of  the  accrued  interest  on  notes  receivable  and  drafts,  but  this 
work  will  be  facilitated  if  postponed  until  after  the  interest  ac- 
count has  been  analyzed.  After  the  analysis  of  the  interest 
account,  the  auditor  is  in  a  position  to  check  or  accrue  the 
interest  in  each  case. 

An  account  is  sometimes  found  which  bears  the  title  "sub- 
scribers to  capital  stock."  In  this  connection  the  auditor  should 
ask  for  a  list  of  the  subscribers,  showing  the  amount  of  the 
original  subscription,  the  amount  which  has  in  each  case  been 
paid  and  the  amount  remaining  unpaid.  It  will  not  be  necessary 
to  ask  for  a  list  if  it  so  happens  that  the  number  of  subscribers 
is  sufficiently  large  to  warrant  opening  a  ledger  for  such  ac- 
counts. This  not  infrequently  happens.  Where  such  is  the  case 
it  will  be  a  matter  of  taking  a  trial  balance  of  such  ledger  and 
agreeing  the  total  with  the  amount  in  the  general  ledger.  In 
the  same  way  the  total  should  be  agreed  in  the  case  of  a  list. 
As  to  the  balances  in  the  individual  accounts,  the  auditor  should 
assure  himself  that  they  are  bona  fide  and  not  simply  dummy 
balances  which  are  being  carried.  An  account  with  John 
Smith  may  show  that  he  subscribed  originally  for  ten  shares 
of  stock— $1,000;  that  he  paid  the  first  call,  or  the  first  instal- 
ment, 25%,  $250,  and  that  the  balance  is  $750.  It  may  appear 
in  the  ledger  as  a  good  balance  but  upon  investigation  may  develop 
that  Smith  has  refused  to  make  subsequent  payments  and  has  in 
fact  forfeited  his  right  to  the  subscription  or  to  the  stock. 

With  regard  to  sinking  funds,  reference  should  be  had  to 
the  indenture  which  provides  for  the  sinking  fund.  By  indenture 
is  meant  the  mortgage.  This  should  be  scrutinized  in  order  to 
see  what  the  terms  are  and  who  the  trustee  or  trustees  are.  If 
the  sinking  fund  is  involved  there  will  be  found  in  the  mortgage 

142 


OTHER   ACCOUNTS    WHICH    REQUIRE  ATTENTION 

a  sinking  fund  clause  which  will  usually  set  forth  all  the  facts 
concerning  it;  that  is,  how  much  of  a  sinking  fund  is  to  be 
provided,  when  the  amount  is  to  be  set  aside,  the  basis  on  which 
it  is  to  be  calculated,  sometimes  the  depositary  and  who  the 
trustee  is  to  be.  It  is  obvious  that  the  auditor  may  not  proceed 
intelligently  without  having  all  of  these  facts  at  his  disposal. 

Having  ascertained  where  the  fund  is  on  deposit,  perhaps 
through  the  courtesy  of  the  trustee  as  it  were,  if  the  trustee  is 
other  than  the  depositary,  a  certificate  should  be  obtained  as  to 
the  amount  of  deposit  and  a  statement  covering  any  interest 
recently  credited.  The  procedure  here  is  the  same  as  that  in 
verifying  a  bank  account.  A  request  should  be  sent  out  to  the 
depositary.  Each  request  should  bear  the  approval  of  the  trustee. 
The  amount  of  deposit  should  agree  with  the  amount  shown  by 
the  ledger  account  in  the  books  of  the  client.  Frequently  the 
depositary  will  have  credited  interest  on  the  sinking  fund  deposit 
which  will  not  yet  have  been  reported  so  that  it  may  be  neces- 
sary to  take  such  interest  into  consideration  in  effecting  the 
reconciliation. 

Subsequent  to  the  reconciliation  the  amount  of  the  sinking 
fund  should  be  verified  in  accordance  with  the  terms  of  the 
sinking  fund  provision.  It  sometimes  happens  that  while  the 
account  of  the  depositary  will  agree  with  the  books  of  the  com- 
pany, the  amount  of  the  sinking  fund  will  not  be  as  large  as  it 
should  be  under  the  terms  of  the  sinking  fund  agreement.  Cases 
have  been  encountered  where  the  company  has  made  a  certain 
number  of  payments  to  the  sinking  fund  and  then  ceased  mak- 
ing payments.  This  would  not  be  disclosed  by  a  certificate. 
The  account  should  be  checked  through  from  the  beginning  to 
the  end  and  verified  chronologically.  This  verification  may  in- 
volve in  certain  instances  the  detailed  calculations  such  as  in 
the  case  of  mining  companies  where  the  amount  of  the  annual 
or  semi-annual  sinking  funds  deposits  depend  upon  the  tons 
of  ore  mined. 

The  sinking  fund  may  exist  in  the  form  of  cash  in  hand 
or  on  deposit,  or  securities  which  have  been  purchased  out  of 
sinking  fund  deposits.  If  the  trust  company  in  which  the  sink- 
ing fund  has  been  deposited  pays  only  2%  on  daily  balances,  or 
3%  on  time  deposits,  the  trustee  may  be  subject  to  criticism, 
unless  his  duties  are  prescribed  and  restricted,  if  he  does  not 

143 


PRINCIPLES  OF  AUDITING 

invest  the  funds  in  securities  which  will  yield  a  higher  return. 
Gilt-edge  securities  to-day  will  yield  3y2%  and  4%  and  not 
much  difficulty  is  experienced  in  finding  such  securities. 

Trustees  who  are  permitted  to  invest  funds  in  securities  as 
soon  as  the  fund  accumulates  sufficiently,  sometimes  prefer  and 
sometimes  are  so  required  to  purchase  outstanding  bonds  of  the 
company  which  makes  the  deposit.  It  is  frequently  argued  that 
such  bonds  are  the  best  possible  investments.  Since  the  object 
of  the  sinking  fund  is  as  a  rule  to  redeem  an  issue  of  outstand- 
ing bonds  it  seems  that  such  procedure  is  not  only  proper  but 
expedient  and  economical.  If  a  company  has  an  issue  of  bonds 
outstanding  on  which  5%  interest  is  paid,  and  on  the  other  hand, 
is  depositing  funds  at  3%  for  the  purpose  of  redeeming  such 
bonds,  it  seems  unbusinesslike  if  the  bonds  may  be  purchased 
at  a  reasonable  figure  to  allow  them  to  remain  outstanding. 
Purchasing  bonds  results  in  shutting  off  the  interest  and  a  saving 
equal  to  the  difference  between  the  interest  received  on  the 
deposit  and  the  interest  paid  on  the  bond,  having  regard,  of 
course,  for  any  premium  which  may  be  involved  in  the  purchase. 
Under  such  circumstances  the  sinking  fund  may  be  found  to 
exist  in  the  form  of  cash,  outside  credits  or  the  company's  own 
securities.  Here,  a  certificate  as  to  the  cash  should  be  obtained 
and  the  securities  either  examined,  which  is  of  course  the  best 
method  of  verification,  or  a  certificate  obtained  from  the  trustee 
as  to  what  securities  he  is  holding  for  account  of  the  fund. 

Securities  of  the  company  may  either  be  cancelled  or  kept 
alive.  If  they  are  cancelled  the  interest  stops  and  they  are 
returned  to  the  company.  If  they  are  kept  alive  the  trustee 
treats  them  as  outside  securities  and  collects  from  the  company 
whatever  interest  attaches.  The  situation  in  this  respect  must 
be  taken  into  consideration  by  the  auditor  later  when  he  reaches 
the  point  of  setting  up  the  balance  sheet.  If  the  bonds  have 
been  cancelled  they  should,  it  seems,  be  deducted  from  the  out- 
standing bonds  on  the  liabilities  side  and  the  net  amount  out- 
standing be  shown.  If  they  have  not  been  cancelled,  they  will 
have  no  effect  on  the  liabilities  and  will  be  carried  along  and 
considered  as  a  part  of  the  sinking  fund.  Here,  again,  the 
opinion  of  the  auditor  may  depend  upon  the  theory  which  he 
holds.  Whether  the  action  of  the  company  is  right  or  wrong 
in  his  opinion  must  be  determined  by  comparing  such  action 

144 


OTHER   ACCOUNTS    WHICH    REQUIRE   ATTENTION 

with  what  he  considers  to  be  right  or  wrong,  and  such  considera- 
tion will  depend  on  what  his  theory  is.  It  is  thus  apparent  that 
before  the  auditor  offers  any  criticism  of  the  method,  he  should 
be  very  sure  as  to  facts  and  have  a  definite  idea  as  to  his  own 
theory. 

One  further  point  should  be  mentioned  before  leaving  the 
subject  of  sinking  funds.  This  is  the  necessity  of  reading  care- 
fully and  trying  to  understand  the  intent  of  the  provisions  with 
regard  to  the  creation  of  the  sinking  fund.  The  wording  of 
mortgages  in  this  respect  is  not  always  as  clear  as  it  might  be. 
It  is  sometimes  difficult  to  determine  just  what  was  intended. 
One  way  of  setting  up  the  accounts  in  connection  with  the  sink- 
ing fund  is  to  make  a  charge  to  profit  and  loss  and  a  credit  to  a 
reserve  for  the  amount  involved  subsequently  funding  the  reserve 
by  transferring  the  amount  from  the  general  cash  to  the  sinking 
fund  cash.  The  other  way  is  to  ignore  the  charge  to  profit  and 
loss  and  the  credit  to  the  reserve  and  transfer  the  amount  from  the 
general  cash  to  the  sinking  fund  cash.  This  has  the  effect  of 
creating  the  fund  but  it  does  not  reserve  the  amount  out  of  the 
profits.  It  is  not  thought  necessary  here  to  discuss  the  relative 
advantages  and  disadvantages  of  these  two  methods.  It  is  the 
desire  rather  to  draw  attention  to  the  fact  that  these  two  possi- 
bilities are  present  and  that  consequently  the  indenture  should 
be  read  carefully  in  order  to  ascertain  if  possible  what  the  intent 
was  in  this  respect. 

The  account  for  discount  on  bonds  should  be  analyzed.  If 
necessary  discount  should  be  distinguished  and  separated  from 
premium.  The  account  should  be  observed  with  regard  to 
whether  or  not  the  discount  is  being  written  off  over  the  life 
of  the  bonds. 

Legal  expense  deferred  should  be  investigated  in  order  to 
determine  what  the  account  really  represents  and  to  see  how 
rapidly  it  is  being  written  off.  There  is  no  reason  as  a  rule  why 
legal  expense  deferred  should  remain  set  up  very  long.  The  idea 
of  going  into  it  is  to  see  that  it  is  bona  fide;  that  it  is  what  it 
purports  to  be.  One  of  the  things  to  look  out  for  is  that  current 
legal  expenses  have  not  been  included  in  the  amount. 

Organization  expense  should  be  analyzed.  The  word  analyzed 
is  here  used  in  a  general  way,  meaning  to  look  into  the  account, 
if  necessary  picking  it  to  pieces  and  finding  out  what  the  details 

US     ' 


PRINCIPLES  OF  AUDITING 

or  items  represent.  The  auditor  should  satisfy  himself  that  the 
account  is  what  it  purports  to  be  and  that  provision  has  been 
made  for  writing  off  the  amount  involved  within  a  reasonable 
time. 

Moving  expense  and  advertising  paid  in  advance  are  practi- 
cally in  the  same  class.  What  was  said  with  regard  to  legal 
expense  deferred  and  organization  expense  applies  to  these  ac- 
counts. Moving  expense  is  sometimes  incurred  in  moving  either 
the  plant  or  office  from  one  place  to  another,  and  may  with 
propriety  be  set  up  temporarily  with  the  intention  of  writing 
it  off  afterwards. 

Advertising  paid  in  advance  should  be  looked  into  to  see  that 
the  amount  set  up  is  proper  and  that  it  is  not  being  carried  too 
long. 

The  account  for  freight  on  consigned  goods  unless  abnor- 
mally large  will  not  as  a  rule  require  any  special  investigation. 
The  only  thing  that  is  liable  to  occur  here  is  some  slight  clerical 
error.  This  account  is,  however,  sometimes  used  for  the  pur- 
pose of  burying  items.  Consequently  the  auditor  will  have  to 
be  guided  in  determining  how  much  work  he  is  to  do  in  connec- 
tion with  this  account  by  the  size  of  the  account  when  considered 
in  relation  to  the  volume  of  business  and  the  nature  of  the 
transactions. 

Interest  and  discount  account,  if  such  an  account  is  found, 
should  be  analyzed  carefully.  While  more  will  perhaps  be  said 
about  the  items  in  this  particular  account  when  discussing  the 
preparation  of  the  report,  one  thought  which  is  of  practical  im- 
portance should  be  noted  here.  This  thought  concerns  the  sum- 
mary. A  great  deal  of  difficulty  and  annoyance  may  be  avoided 
if  in  summarizing  the  result  of  an  analysis  like  that  in  the  case 
of  interest  and  discount,  care  is  observed  in  setting  out  in  the 
summary  the  dates  in  connection  with  the  interest  items.  Sup- 
pose for  example  in  the  analysis  of  the  interest  account  there 
is  found  interest  on  $10,000  worth  of  Rock  Island  4's.  Suppose 
further  that  the  interest  received  was  for  the  six  months  ended 
November  30.  At  the  time  of  receipt  it  was  charged  to  cash 
and  credited  to  interest  earned  on  securities.  It  is  obvious  then 
that  if  December  31  is  the  close  of  the  period  under  audit  that 
interest  for  one  month  on  these  securities  will  have  to  be  ac- 
crued. By  setting  forth  in  the  summary  the  details  as  to  the 

146 


OTHER   ACCOUNTS    WHICH    REQUIRE   ATTENTION 

period  covered  by  the  interest  on  the  Rock  Island  4's  it  will 
be  an  easy  matter  to  make  the  correct  accrual  at  the  proper  time. 
If  this  is  not  set  forth  in  the  summary  the  chances  are  that  a 
great  deal  of  time  will  be  lost  by  the  person  making  up  the  report 
in  searching  through  the  papers  to  find  the  period  which  the 
interest  covered.  On  the  other  hand,  if  such  information  is  set 
forth  clearly  in  the  summary  it  is  only  the  work  of  a  moment 
in  each  case  to  calculate  the  accrual.  These  same  remarks  might 
have  been  made  with  equal  application  in  the  case  of  notes  re- 
ceivable and  bonds  and  mortgages  or  in  other  securities  or 
instruments  on  which  interest  runs. 

Royalties  may  be  either  those  paid  or  received.  In  either 
case  there  will  undoubtedly  have  been  a  royalty  contract  or 
agreement.  This  should  be  requested  and  the  instrument  read 
in  order  to  ascertain  the  substance  thereof  and  the  terms.  Royalty 
is  based  usually  on  articles  or  goods  manufactured  or  sold.  It 
is  well  to  be  sure  concerning  the  basis  since  some  contracts  are 
based  on  production  and  some  on  sales.  The  word  "output"  is 
sometimes  used  and  where  used  the  auditor  should  have  some- 
one who  is  competent  place  the  construction  on  the  word  for 
him.  He  should  make  a  schedule  of  the  goods  or  equipment 
involved  together  with  the  price  on  which  the  royalty  is  to  be 
computed  and  then  ask  for  copies  of  the  royalty  statements 
which  he  should  check. 


CHAPTER  XXI 

ACCOUNTS  ON  THE  CREDIT  SIDE 

Perhaps  the  most  important  item  in  this  group  is  bonds. 
Bonds  as  a  rule  are  secured  by  mortgages.  Mortgages  are  fre- 
quently referred  to  as  indentures.  It  is  essential  if  an  intelligent 
audit  is  to  be  made  that  the  mortgage  be  read.  Usually  it  con- 
tains the  description  and  wording  of  the  bond.  The  original 
document  will  rarely  be  seen.  It  is  usual  to  receive  a  printed 
copy  in  pamphlet  form. 

The  mortgage  should  be  read  for  specifications  with  regard 
to  such  matters  as  the  date  of  issue,  the  par  of  each  bond,  and 
the  dates  of  payment  thereof  and  for  special  provisions  such  as 
the  following: 

"Any  bonds  issued  beyond  the  first  five  million  dollars  must 
be  limited  to  80%  of  the  amount  expended  for  additional  equip- 
ment or  property  and  no  bond  beyond  the  first  five  million  dol- 
lars shall  be  issued  at  any  time  unless  the  net  earnings  of  the 
company  for  the  preceding  year  shall  be  equal  to  at  least  twice 
the  interest  charged  for  one  year  on  the  bonds  outstanding  and 
on  those  to  be  immediately  issued." 

If  an  auditor  is  to  do  his  work  intelligently,  he  should  be 
cognizant  of  special  provisions  of  this  kind  and  keep  them  in 
mind  in  doing  his  work. 

In  regard  to  registration  considerable  variation  will  be  found. 
Some  bonds  may  be  registered  as  to  principal  and  some  as  to 
interest.  Very  often  the  following  restriction  will  be  found: 

"Bonds  may  be  registered  as  to  principal  or  as  to  both  prin- 
cipal and  interest.  Bonds  once  registered  as  to  principal  and 
interest  cannot  be  exchanged  for  coupon  bonds." 

There  may  also  be  special  stipulations  as  to  redemption.  The 
arrangement  is  frequently  made  that  bonds  may  be  drawn  after 
a  given  number  of  years  at  a  price,  for  example,  not  to  exceed 
105.  Occasionally  some  of  the  provisions  with  regard  to  redemp- 
tion are  more  complicated.  In  the  case  of  a  certain  bond  it  is 
provided  "that  bonds  shall  be  redeemable  on  April  1,  1924,  at 
1071/2  and  interest  and  thereafter  due  notice  being  given  on  any 
interest  date  at  a  price  decreasing  at  the  rate  of  one-half  of  one 

148 


ACCOUNTS   ON   THE   CREDIT   SIDE 

per  cent  yearly  to  maturity."  All  such  things  should  be  kept 
in  mind  if  the  work  of  the  auditor  is  to  be  of  a  higher  order. 

Some  attention  should  perhaps  be  given  to  the  distinction 
between  coupon  bonds  and  registered  bonds.  The  former  have 
sheets  of  small  coupons  covering  the  payment  of  interest  and 
which  may  be  clipped  from  time  to  time  as  the  interest  becomes 
due.  There  is  nothing  about  a  coupon  bond  to  indicate  owner- 
ship. It  may  pass  from  one  person  to  another  very  much  like 
cash.  The  issuing  company  is  indifferent  as  to  the  owner. 

Registered  bonds  are  quite  different.  Such  bonds  must  be 
registered  with  the  company  or  some  designated  registrar  in 
order  that  the  company  may  know  to  whom  the  interest  is  to  be 
paid.  The  interest  on  registered  bonds  is  paid  by  check.  While 
a  bond  coupon  is  very  much  like  a  check  it  is  drawn  to  bearer 
rather  than  to  order.  If  one  might  imagine  a  number  of  minia- 
ture checks  drawn  in  advance,  dated  in  advance,  printed  in  sheets 
and  attached  to  a  registered  bond,  a  proper  idea  of  a  coupon  bond 
would  be  had.  In  other  words,  there  is  no  difference  between  a 
coupon  bond  and  a  registered  bond  so  far  as  the  bond  proper  is 
concerned.  The  difference  consists  merely  in  the  provision  which 
is  made  for  the  payment  of  interest  in  the  one  case.  This  is 
arranged  in  advance  by  attaching  the  coupons  to  the  bond.  In 
the  case  of  the  registered  bond  the  checks  are  drawn  to  order 
from  time  to  time  as  the  interest  matures. 

An  interesting  question  which  arises  in  connection  with  the 
amount  of  bonds  outstanding,  is  how  to  verify  it.  In  the  case  of 
coupon  bonds  the  situation  is  different  from  that  in  which  there 
are  registered  bonds.  There  is  one  way,  however,  which  is  com- 
mon to  both,  namely,  in  case  the  bonds  are  outstanding,  tracing 
the  receipts  through  the  cash  book  or  journal.  If  the  bonds  are 
outstanding  it  is  apparent  that  something  should  have  been  re- 
ceived in  exchange  for  them  and  this  may  have  been  cash.  If 
from  the  inspection  of  the  cash  book  this  does  not  prove  to  be 
the  case,  the  auditor  must  go  a  step  further  and  search  through 
the  journal.  In  the  case  of  coupon  bonds  the  coupons  are  valuable 
in  establishing  fairly  accurately  the  amount  of  principal  out- 
standing. Each  coupon  bears  the  number  of  the  bond  to  which  it 
was  attached.  After  the  coupons  have  been  paid  and  returned, 
by  establishing  the  sequence  of  numbers  and  taking  into  con- 
sideration the  period  covered  by  the  coupon,  the  amount  of 

149 


PRINCIPLES  OF   AUDITING 

bonds  outstanding1  may  be  checked.  As  a  practical  matter  this 
method  may  be  subject  to  slight  variation  where  coupons  have 
not  yet  come  in.  The  method  does,  however,  furnish  an  effective 
check  on  the  amount  which  is  in  the  majority  of  cases  sufficiently 
accurate.  In  a  similar  manner,  in  the  case  of  registered  bonds, 
the  returned  checks  may  be  made  to  serve  as  vouchers  not  only 
of  payment  of  the  interest  but  as  a  check  on  the  amount  of 
principal  outstanding. 

Different  concerns  have  different  schemes  for  filing  coupons 
after  they  have  come  back  as  a  result  of  having  been  detached 
by  the  holders,  put  in  the  bank  for  collection,  paid  by  the  bank 
or  trust  company  and  returned  to  the  company.  One  scheme 
consists  in  providing  a  book  of  cheap  paper  ruled  off  in 
spaces  corresponding  to  the  size  of  the  coupons  and  pasting 
the  coupons  therein  numerically.  Other  concerns  instead  of 
pasting  the  coupons  in  books  keep  them  done  up  in  packages; 
sometimes  in  small  tin  boxes.  It  is,  of  course,  easier  to  count 
them  if  they  are  pasted  into  a  book,  as  for  example,  if  there 
are  fifty  to  a  page,  one  may  count  them  in  lots  of  fifty  by 
glancing  at  each  page  to  see  if  it  has  been  filled  up.  An  out- 
standing coupon  is  immediately  brought  to  attention,  whereas, 
it  might  be  overlooked  in  counting  them  if  they  were  in  packages. 

The  amount  of  registered  bonds  outstanding  may  be  checked, 
first  by  tracing  receipts  into  the  cash  book  or  following  the  trans- 
actions through  the  journal.  Second,  by  obtaining  a  list  from  the 
registrar  or  from  the  bond  register  kept  by  the  company,  and 
third,  from  the  interest  payments  as  indicated  by  the  interest 
checks.  The  method  used  in  the  case  of  the  interest  check  is  not 
different  from  that  where  there  are  interest  coupons. 

At  the  time  of  verifying  the  interest  paid  on  bonds  outstand- 
ing, either  through  the  cancelled  coupons  or  cancelled  checks 
which  serve  as  vouchers,  the  interest  accrued  on  the  bonds  out- 
standing may  be  checked.  So  far  as  the  company  is  concerned 
the  usual  practice,  altho  the  practice  may  vary,  is  to  make  an 
entry  charging  interest  on  bonds  and  crediting  interest  accrued 
on  bonds.  There  is  then  transferred  out  of  the  general  cash,  an 
amount  equal  to  the  payment  of  interest,  which  amount  is  placed 
in  a  special  deposit  account  with  some  bank  or  trust  company  or 
fiscal  agent.  As  coupons  or  interest  checks  are  paid  and  returned 
by  the  fiscal  agent,  interest  accrued  on  bonds  is  charged  and 


ACCOUNTS   ON   THE   CREDIT   SIDE 

cash  on  deposit  for  the  payment  of  interest  is  credited.  Two  things 
then  in  the  matter  of  verification  have  to  be  kept  in  mind,  namely, 
the  balance  of  cash  in  the  special  account  on  the  one  side  and  the 
liability  for  the  unpaid  interest  on  the  other.  The  verification  of 
the  balance  of  cash  is  effected  by  obtaining  a  certificate  from 
the  fiscal  agent  and  comparing  the  amount  so  reported  with  the 
amount  ascertained  by  totaling  the  coupons  or  interest  checks 
outstanding.  The  term  fiscal  agent  is  used  here  as  a  general 
term  to  indicate  banks,  trust  companies  and  fiscal  representatives. 
A  specific  illustration  may  serve  to  make  clear  the  foregoing. 
Consider,  for  example,  that  the  period  under  review  is  the  fiscal 
year  ended  December  31,  1914.  The  bonds  of  the  Blank  Com- 
pany bear  interest  which  is  payable  at  the  rate  of  6%  per  annum, 
January  1  and  July  1 ;  the  principal  outstanding  $100,000.  Under 
such  circumstances  $3,000  must  be  paid  as  interest  on  the  first 
day  of  July  for  the  six  months  ended  June  30  and  a  similar 
amount  on  the  first  day  of  January  for  the  six  months  ended 
December  31.  In  examining  the  records  for  purposes  of  audit, 
it  is  found  that  there  appear  in  the  books  so  far  as  the  assets  and 
liabilities  are  concerned,  an  account  with  a  debit  balance  in  the 
amount  of  $3,000  termed  coupon  deposit  and  an  account  with  a 
credit  balance  in  the  amount  of  $3,000  termed  interest  accrued  on 
bonds.  The  situation  will  depend,  of  course,  on  the  date  at 
which  the  verification  is  attempted.  If  the  fiscal  agents  were 
requested  to  report  the  amount  in  the  coupon  deposit  account  of 
the  Blank  Company  on  December  31,  they  would  naturally  report 
$3,000.  If,  however,  the  report  were  requested  some  time  in 
January,  the  balance  would  not  be  $3,000  but  something  less  in 
accordance  with  the  number  of  coupons  or  checks  which  had 
been  presented  to  and  paid  by  the  fiscal  agents  since  the  first  of 
January.  If  the  balance  under  such  circumstances  as  reported 
happened  to  be  $630,  then  provided  the  company  had  received  all 
cancelled  coupons  or  checks,  the  auditor  would  expect  to  find 
after  having  examined  such  cancelled  coupons  and  checks,  twenty- 
one  of  same  outstanding.  Each  coupon  being  in  the  amount  of 
$30  the  amount  of  such  outstanding  coupons  would  be  $630.  This 
amount  being  in  agreement  with  the  balance  on  deposit,  the 
verification  would  be  complete. 

In  the  above  illustration  the  situation  is  fairly  simple.    Compli- 
cations arise  where  the  bond  interest  periods  do  not  coincide  with 


PRINCIPLES  OF   AUDITING 

the  end  of  the  year.  In  the  illustration  above  mentioned  if  the 
interest  dates  had  been  April  and  October  instead  of  January 
and  July,  and  the  company  had  been  in  the  habit  of  accruing  the 
interest  monthly,  before  the  verification  could  have  been  effected, 
it  would  have  been  necessary  to  have  deducted  from  the  amount 
shown  in  the  interest  accrued  on  bonds  account,  the  interest 
accrued  from  September  30  to  December  31.  In  other  words,  the 
account  interest  accrued  on  bonds  may,  if  the  interest  dates  do 
not  coincide  with  the  fiscal  year,  show  two  things,  one,  interest 
accrued,  due  and  unpaid,  and  interest  accrued,  not  due. 

Further  complications  in  the  interest  accrued  account  will 
at  times  be  encountered.  Where  there  are  several  series  of  bonds 
especially  where  the  interest  is  not  collected  promptly  by  the 
holders  of  coupons,  the  balance  in  the  interest  accrued  account 
may,  for  example,  be  $630.  This  amount  may  be  made  up  of 
amounts  corresponding  to  the  different  interest  coupons;  $420 
may  represent  coupon  No.  25,  $150  may  represent  coupon  No.  24, 
$60  may  represent  coupon  No.  23  and  so  on  back.  In  the  same 
way  different  series  of  bonds  may  affect  the  situation.  Conse- 
quently in  verifying  statements  received  from  fiscal  agents  care 
should  be  had  in  seeing  that  the  interest  accrued  which  is  due  and 
payable  is  not  only  represented  in  the  aggregate  by  the  coupon  de- 
posit account  but  that  the  deposit  for  each  class  of  coupons  or 
numbers  as  the  case  may  be,  corresponds  with  the  liability  there- 
for. Registered  bonds  are  worked  out  in  the  same  way  except 
that  there  will  be  checks  instead  of  coupons  for  the  interest.  The 
various  outstandings  should  be  listed  and  the  respective  accounts 
reconciled. 

Dividends  declared  and  unpaid  are  similar  in  their  nature  to 
interest  accrued.  Dividends  are  paid  by  check.  The  important 
thing  to  ascertain  in  connection  with  this  account  is  that  the 
fund  on  deposit  equals  the  liability.  The  procedure  is  the  same 
as  that  in  the  case  of  interest  paid  by  check. 

Loans  payable  are  among  the  accounts  which  merit 
careful  consideration.  It  might  have  been  said  while  the 
cash  book  was  being  discussed,  that  it  is  desirable  for 
the  auditor  to  scrutinize  the  cash  receipts  for  any  receipts 
on  account  of  loans  or  notes  payable  and  to  make,  for 
further  reference,  a  list  of  such  receipts.  If  the  auditor  has 
failed  to  make  a  list  at  the  time  of  going  through  the  cash  receipts, 

152 


ACCOUNTS  ON   THE   CREDIT   SIDE 

which  might  very  easily  happen,  as  it  is  not  always  convenient  so 
to  do,  he  should  go  back  and  make  such  a  list  before  attempting 
to  verify  the  loans  payable.  Such  list  should  be  checked  against 
the  schedule  of  loans  said,  at  the  time  of  the  audit,  to  be  out- 
standing. Altho  perhaps  it  is  not  done  as  frequently  as  it  should 
be,  it  is  a  good  plan  to  verify  the  loans  and  notes  payable  by 
correspondence.  In  this  connection  it  is  important  that  care 
should  be  exercised  in  the  wording  of  the  request.  The  party 
addressed  should  be  asked  to  report  what  notes  or  loans  against 
the  client  in  question  are  being  held.  If  one  were  to  write  and  say 
"Are  you  holding  a  note  of  $50,000  against  A.  Blackwell  ?"  such 
person  might  reply  that  he  is  holding  such  a  note  but  say  nothing 
about  a  further  note  in  the  amount  of  $25,000.  If  the  inquiry  is 
made  sufficiently  broad  and  is  carefully  worded,  the  information 
furnished  is  liable  to  be  more  complete. 

Frequently  such  an  inquiry  will  develop  loans  other  than  those 
shown  on  the  books.  In  the  same  way  such  procedure  will  some- 
times establish  an  endorsement  relation.  It  may  be  found  perhaps 
that  a  corporation  has  endorsed  notes  for  some  individual  or 
vice  versa  and  such  things  may  be  interesting  to  the  auditor  in  his 
work.  All  such  relations  should  be  ascertained  as  far  as  possible 
as  they  frequently  throw  light  on  the  general  situation  which  is 
interesting.  Of  course,  there  is  no  way  of  ascertaining  the  facts 
if  a  man  goes  to  John  Jones  and  borrows  $5,000  from  him  giving 
his  note  and  makes  no  record  of  the  note  or  cash  on  the  books. 
The  auditor  will  find,  however,  that  if  he  follows  the  rule  of 
spreading  his  net  in  every  direction  he  will  frequently  discover 
matters  of  this  kind  in  the  most  unexpected  manner. 

In  connection  with  accounts  payable  one  may  either  take  a 
trial  balance  of  the  creditors'  ledger  or  obtain  a  trial  balance  and 
check  it  against  such  ledger,  agreeing  the  totals  of  the  accounts 
payable  with  the  control.  As  a  general  rule  a  trial  balance  will 
probably  have  been  already  prepared.  It  is  seldom  that  one  has 
to  be  taken  off.  This  is  true  of  the  accounts  payable  as  it  is 
generally  true  of  accounts  receivable.  If  a  voucher  record  is 
maintained  without  a  creditors'  ledger  in  connection  with  it  as 
seldom  happens,  it  will  be  necessary  either  to  check  the  list  of 
accounts  unpaid  and  outstanding  or  prepare  such  a  list.  The 
open  accounts  so  listed  should  be  totaled  and  the  total  agreed 
with  the  balance  in  the  controlling  account  in  the  general  ledger. 

153 


'  PRINCIPLES  OF  AUDITING 

Any  accounts  receivable  which  may  be  included  in  the  ac- 
counts payable  ledger  should  be  taken  out  and  set  up  separately. 
For  example,  the  trial  balance  of  the  creditors'  ledger  might 
amount  to  $10,100.  Such  an  amount  might  be  made  up  of 
hundreds  of  credit  items  amounting  to  $10,000  with  numerous 
debit  balances  amounting  to  $100,  acting  as  offsets.  It  is  im- 
portant that  in  going  over  the  trial  balance  such  debit  items 
should  be  listed  and  totaled  in  order  that  in  preparing  the  bal- 
ance sheet  the  true  situation  may  be  shown  with  regard  to  ac- 
counts payable  as  well  as  that  with  regard  to  accounts  receivable. 
The  point  is  that  the  accounts  receivable  may  not  be  used  in 
settlement  of  the  accounts  payable,  consequently  they  may  not  be 
treated  properly  as  offsets.  Because  such  accounts  are  kept  in 
the  creditors'  ledger  as  a  matter  of  convenience,  is  no  reason  why 
they  should  be  looked  upon  as  reducing  the  liability  in  favor  of 
creditors.  Accounts  payable  is  a  general  term  as  is  accounts 
receivable.  Individual  accounts  are  something  different.  If  such 
individual  accounts  receivable  could  be  treated  as  offsets  there 
would  be  no  purpose  in  having  accounts  for  them  in  the  creditors' 
ledger  since  they  would  be  applied  against  various  individual 
credit  balances. 

Ageing  accounts  payable  may  be  as  interesting  as  ageing  ac- 
counts receivable.  This  work  in  connection  with  accounts  pay- 
able will  show  the  relative  need  for  funds  and  whether  or  not  the 
credit  of  the  concern  is  being  strained.  This  is  as  important  at 
times  as  knowing  whether  or  not  accounts  receivable  are  good  or 
bad.  This  may  not,  however,  be  undertaken  without  due  regard 
for  the  length  of  time  involved  and  the  circumstances  of  the  case 
in  question. 

While  it  is  perhaps  not  as  common  to  send  out  for  statements 
with  regard  to  accounts  payable  as  it  is  to  send  out  statements 
showing  accounts  receivable,  it  is  a  very  good  thing  to  do.  Send- 
ing to  creditors  and  asking  for  statements  of  account  with  them 
in  case  they  do  not  come  in  as  a  part  of  the  regular  routine  is 
very  helpful  in  verifying  balances.  Frequently  in  so  doing  un- 
adjusted items  or  items  in  dispute  will  be  brought  to  attention. 
This  offers  an  opportunity  of  checking  up  the  items  in  question 
with  a  view  to  adjusting  them. 

Looking  through  the  cash  disbursements  for  invoices  paid  in 
periods  to  which  they  do  not  belong  is  an  important  thing  to 

154 


ACCOUNTS  ON  THE  CREDIT  SIDE 

have  in  mind.  It  quite  frequently  happens  that  business  con- 
cerns will  at  the  end  of  December,  for  example,  ignore  December 
invoices  which  happen  to  be  late.  In  closing  the  books  no 
cognizance  is  taken  of  the  liability  in  connection  with  such 
invoices  and  they  are  simply  paid  in  the  course  of  time  and 
charged  in  the  month  of  January,  or  some  succeeding  month,  to 
the  appropriate  expense  accounts.  These  invoices  may  be  found 
scattered  along  through  January,  February,  March  and  some- 
times as  far  as  April.  If  the  accounts  are  to  be  maintained  on 
an  accrual  rather  than  a  cash  basis,  it  is  necessary  that  such 
items  be  thrown  back,  as  it  were,  so  that  any  invoices  applicable 
to  the  preceding  period  will  be  taken  up  in  such  period.  In 
order  to  catch  such  items  the  auditor  should  observe  carefully  all 
vouchers  during  the  first  three  months  of  the  period  under  review 
as  well  as  the  three  months  succeeding  the  period.  Items  which 
do  not  affect  the  period  may  thus  be  thrown  out,  while  items 
which  do  affect  the  period  may  be  taken  up.  For  similar  reasons 
and  extending  over  similar  periods  the  cash  book  should  be 
scrutinized.  In  connection  with  this  work  it  should  be  kept  in 
mind  that  there  may  be  items  of  cash  receipts  and  disbursements 
which  work  in  the  reverse  way.  Rent  paid  in  December  for  the 
month  of  January  would  need  to  be  set  up  if  a  strict  accrual 
basis  is  to  be  maintained.  Where  the  audit  takes  place  immediately 
after  the  close  of  the  period,  it  may  be  necessary  to  examine  the 
vouchers  of  the  last  month  with  particular  reference  to  items 
which  are  in  the  nature  of  monthly  expenses  so  that  proper 
accrual  of  these  items  may  be  made  in  the  report.  Some  judg- 
ment should  be  used,  however,  in  matters  of  this  kind  and  the 
total  amount  involved  with  its  effect  upon  the  situation  taken 
into  consideration  before  undertaking  this  work. 

A  few  words  should  be  said  as  to  the  manner  of  verifying  the 
amount  of  capital  stock  outstanding.  A  stock  certificate  book 
looks  very  much  like  a  check  book.  Stock  certificates  have  stubs 
just  as  do  checks.  The  stub  provides  for  the  number  of  the 
certificate,  the  number  of  shares,  the  name  and  address  of  the 
party  to  whom  it  was  issued,  the  date  of  Issue,  what  it  was  issued 
for  and  from  whom  transferred,  if  issued  in  exchange  for  stock 
previously  issued ;  also  the  date,  number  of  the  original  certificate, 
number  of  original  shares,  number  of  shares  transferred  and  a 
place  for  the  receipt  of  the  party  to  whom  the  stock  is  issued. 

155 


PRINCIPLES  OF  AUDITING 

Of  course,  if  the  certificate  is  issued  for  cash,  all  this  informa- 
tion will  not  appear.  The  stub  will  show  in  such  cases  the  number 
of  the  certificate,  the  number  of  shares,  to  whom  issued  (name 
and  address)  and  a  place  for  the  receipt.  If  Mr.  Smith  wishes 
to  transfer  two  shares  out  of  the  ten  which  he  owns  to  Mr.  Jones, 
he  sends  in  to  the  company  or  its  transfer  agent,  the  certificate 
calling  for  ten  shares.  The  certificate  is  cancelled  and  pasted 
back  into  the  book  on  the  stub.  Two  new  certificates  are  then 
issued,  one  for  eight  shares  and  one  for  two  shares.  The  open 
stubs  in  the  stock  certificate  book  should  then  represent  the  stock 
outstanding.  Consequently  this  offers  one  opportunity  of  verify- 
ing the  amount  outstanding.  If  the  auditor  will  go  through  the 
stock  certificate  book,  making  a  list  from  the  open  stubs  show- 
ing the  number  of  the  certificate  and  the  number  of  shares  repre- 
sented by  each  stub  and  total  up  such  list,  he  will  have  an  amount, 
which  upon  comparison,  should  agree  with  the  capital  stock 
shown,  by  the  ledger,  as  being  outstanding. 

Another  way  of  verifying  this  amount  consists  in  taking  off  a 
trial  balance,  as  it  were,  of  the  stock  ledger.  Corporations  in 
New  York  state  as  well  as  various  other  states  are  obliged  by 
law  to  keep  a  stock  book.  No  matter  what  the  form,  the  effect  is 
that  of  opening  a  ledger  account  with  each  owner  of  stock  show- 
ing the  number  of  shares  held  by  each  individual  owner.  Taking 
off  a  trial  balance  from  such  book  and  making  a  list  of  the  names 
and  the  number  of  shares  held,  will  accomplish  the  same  purpose 
as  making  a  list  from  the  stubs.  Under  one  procedure  the  in- 
formation appears  according  to  certificates;  under  the  other, 
according  to  owners. 

Charge  sales  for  three  or  four  months  should  be  tested  by 
checking  the  duplicate  sales  slips  or  invoices  against  the  sales 
books.  Cash  sales  may  be  verified  at  times  from  the  subsidiary 
books  in  which  the  details  of  the  sales  are  entered,  by  footing 
such  books  and  checking  the  totals  into  the  general  cash  book. 

As  a  check  on  the  income  which  arises  through  interest  on 
bonds,  the  interest  should  be  followed  through  in  order  to  ascer- 
tain whether  or  not  any  portion  of  the  interest  should  have  been 
credited  to  interest  purchased,  accrued  interest  or  amortization. 
In  a  majority  of  cases  it  may  be  said  the  matter  of  amortization 
need  not  be  considered.  An  ordinary  mercantile  concern  will 
probably  have  no  bonds.  On  the  other  hand,  an  insurance  com- 

156 


ACCOUNTS  ON  THE  CREDIT   SIDE 

pany  or  railroad  will  probably  have  large  holdings  and  various 
bonds  may  be  held  in  large  blocks,  so  that  the  matter  of  amortiza- 
tion will  be  of  vital  importance.  By  following  the  interest  through 
is  meant  ascertaining  with  regard  to  each  holding,  the  situation 
concerning  the  interest  at  the  beginning  of  the  period  and  follow- 
ing the  period  through  in  order  to  see  that  the  interest  has  been 
regularly  collected  and  that  no  period  has  been  skipped.  To 
make  clear  the  matter  of  interest  purchased  and  accrued  interest, 
assume  for  example,  that  a  one  thousand  dollar  bond  bearing 
interest  at  6%  was  purchased  on  the  first  of  November.  The 
interest  dates  are  April  1  and  October  1.  Six  per  cent  (6%)  on 
$1,000  would  be  $60  for  the  year.  One  month  would  be  $5. 
October  1  to  November  1  would  be  one  month.  The  interest 
involved  would  be  $5.  If  the  bond  in  question  had  been  pur- 
chased on  the  first  of  November  at  par,  $1,005  would  have  been 
paid  for  it,  the  $5  representing  the  accrued  interest.  On  the  first 
of  the  following  April  the  coupon  would  be  clipped  and  $30 
would  be  collected.  The  entire  $30  should  not  be  credited  to 
interest  earned  because  only  $25  has  been  earned.  The  other  $5 
is  interest  purchased.  If  it  so  happens  that  interest  has  been 
accrued  on  the  books  from  the  first  of  October  to  the  end  of 
December,  then  the  $30  would  have  to  be  divided  still  differently. 
Five  dollars  ($5)  should  be  credited  to  interest  purchased,  $10 
to  interest  accrued  and  $15  to  interest  earned.  Since  the  matter 
of  amortization  may  also  be  involved,  it  will  be  seen  that  there 
might,  under  certain  circumstances,  be  four  credits  in  connection 
with  interest  received,  namely,  interest  purchased,  accrued  in- 
terest, interest  earned  and  amortization. 

Income  may  also  be  received  on  account  of  dividends  on 
stocks.  As  a  step  precedent  to  the  checking  of  this  item  of 
income,  the  history  of  such  stocks  as  are  involved  should  for  the 
period  under  review  be  looked  up  with  regard  to  the  dividend 
relations,  in  some  publication  such  as  The  Commercial  and 
Financial  Chronicle.  This  information  should  embrace  the  dates 
of  any  regular,  extra,  special  and  stock  dividends  and  the  rates 
in  each  case.  This  furnishes  an  independent  basis  from  which 
to  work  in  checking  the  dividends  receipts  as  shown  by  the  books 
of  the  client. 

Commissions  earned  will  be  handled  much  like  royalties. 
Statements  will  be  made  up  either  by  the  principal  or  the  agent 

157 


PRINCIPLES  OF  AUDITING 

showing  the  volume  of  business  on  which  the  commissions  are 
computed.  The  amount  of  commission  earned  as  shown  by  the 
statements  should  be  checked  against  the  ledger  account. 

Exchange  will  usually  be  an  account  small  in  amount  repre- 
senting collection  charges  on  out  of  town  checks  and  will  not 
usually  require  any  attention.  The  account  may,  however,  in  the 
case  of  certain  concerns  represent  the  cost  of  foreign  exchange 
purchased  or  sold,  or  the  profit  and  loss  on  purchases  and  sales 
of  foreign  exchange.  If  the  concern  happens  to  be  one  which 
deals  in  foreign  exchange,  a  subsidiary  book  or  statements  of 
some  kind  showing  the  details  of  the  transactions  will  usually  be 
found.  If  the  account  is  of  sufficient  size  or  the  transactions  are 
of  sufficient  importance,  the  account  should  receive  more  careful 
treatment  than  where  only  collection  charges  are  involved. 

The  profit  and  loss  account  should  be  analyzed.  Explanation 
should  be  required  of  all  items  which  are  not  clear.  If  items 
written  off  are  large  in  amount,  the  auditor  should  ascertain  by 
whom  such  entries  were  authorized.  It  is  perhaps  not  a  bad  idea 
to  analyze  the  profit  and  loss  account  during  the  early  part  of 
the  engagement  rather  than  leave  it  until  the  end  as  it  often 
develops  leads  which  may  be  used  to  advantage  in  analyzing 
other  accounts. 


158 


CHAPTER   XXII 

•v 

How  TO  END  AN  AUDIT 

Before  leaving  the  office  of  the  client  or  the  place  in  which 
the  work  has  been  carried  on,  the  trial  balance  and  supporting 
analyses  and  summaries  should  be  looked  over  and  journal  entries 
made  for  any  matters  which  require  adjustment.  If  it  is  not 
possible  to  make  the  journal  entries  at  the  time  the  information 
should  be  jotted  down  so  that  it  will  be  available  when  needed. 
It  is  preferable  that  journal  entries  be  made  immediately  while 
the  matter  is  fresh  in  the  mind  and  so  that  proper  and  adequate 
explanation  may  be  made.  This  is  so  that  if  anything  develops 
which  requires  attention,  access  to  the  books  and  records  may 
be  had  or  any  questions  may  be  asked  before  leaving.  By  adjust- 
ments is  meant  any  changes  or  corrections  in  the  figures  as  shown 
in  the  books,  or  any  additions  thereto. 

Adjustments  may  be  roughly  divided  into  three  classes : 

First,  adjustments  to  cover  things  done  which  should  not 
have  been  done.  These  are  sometimes  called  errors  of 
principles  or  errors  of  commission. 

Second,  adjustments  to  cover  things  which  have  been  done 
but  have  been  done  incorrectly.  Under  this  head  come 
clerical  and  offsetting  errors  and  errors  in  the  mechanical 
work. 

Third,  adjustments  to  cover  things  which  have  not  been 
done.  These  are  frequently  referred  to  as  errors  of  omis- 
sion. 

As  an  illustration  of  the  first  point  may  be  mentioned  capitaliz- 
ing expense.  One  of  the  principles  of  accounting  is  that  any  debit 
item  which  does  not  add  to  the  value  of  property  or  otherwise 
increase  the  assets  should  be  charged  to  expense.  The  book- 
keeper may  not  have  a  clear  understanding  of  this  point  and  may 
charge  certain  items  of  expense  to  the  property  accounts.  An 
error  not  uncommon  in  this  respect  is  that  of  charging  taxes  to 
the  cost  of  property.  This  it  should  be  understood  is  property 
which  is  being  operated  and  not  that  which  is  being  developed  by 

159 


PRINCIPLES  OF  AUDITING 

a  real  estate  concern  for  sale.  The  charging  of  taxes  to  the 
property  account  constitutes  an  error  in  principle. 

In  the  second  class  there  are  of  course  many  more  possibili- 
ties. Among  these  are  incorrect  figuring,  extending  or  footing 
of  sales  invoices,  mistakes  in  preparing  vouchers,  mistakes  in 
making  entries  in  the  books,  mistakes  in  posting,  footings  carried 
forward,  etc.  These  errors  while  perhaps  of  greater  frequency, 
are  less  liable  to  involve  large  amounts  and  are  as  a  rule  of  less 
importance. 

Failure  to  set  up  unexpired  insurance,  if  the  amount  is  of 
sufficient  importance,  at  the  time  of  closing  the  books,  constitutes 
an  example  of  an  error  of  omission.  In  fact  failure  to  make 
proper  accruals  at  such  time  may  probably  be  said  to  account  for 
most  of  the  errors  of  omission.  There  may  also  be  included  such 
matters  as  crediting  sales  of  securities  and  accrued  interest  tempo- 
rarily to  the  securities  account  and  failing  to  clear  the  account 
properly  at  the  time  of  closing  the  books. 

A  few  entries  in  illustration  of  adjustments  follow : 

Endowment  fund $100.00 

To  Endowment  fund  reserve $100.00 

To  correct  error  in  charging  the  reserve 
and  crediting  cash  when  investing  the 
fund. 


Subscriptions $25.00 

To  Sustaining  members $25.00 

To  correct  error  in  posting. 


Interest  payable $163.58 

To  Interest  accrued $163.58 

For  interest  accrued  on  note  of  $5,392.92; 
six  months  at  6%  per  annum. 


Accrued  interest $23.77 

To  Interest $23.77 

To  set  up  interest  credited  by  the  Title 
Guarantee  &  Trust  Company  and  not 
taken  up  in  the  income  at  December  31, 
1914. 

160 


HOW  TO  END  AN  AUDIT 


Unexpired  insurance $391.68 

To  Insurance $391.68 

To  set  up  the  unexpired  insurance  premiums 
at  December  31,  1914. 


Accrued  interest  on  investments $335.52 

To  Interest  on  investments $335.52 

To  set  up  on  the  book  the  accrued  interest 
on  investments  at  the  time  of  closing  the 
books  December  31,  1914: 
Central  Railroad  of  New  Jersey 

bonds $6.25 

New  York  City  corporate  stock. .       3.54 
Bonds  &  mortgages: 

Baer 6773 

Dean    37.50 

Chadwick   35.00 

Munson  81.25 

Wahlsen  .,  .  104.25 


$335.52 

City  of  New  York $165.57 

To  Care  of  patients,  City  of  New  York  $165.57 

To  adjust  the  estimated  charges  against  the 
City  of  New  York  to  the  actual  charges : 
Actual : 

November,  1914.  .$1,600.57 
December,   1914..   1,265.00    $2,865.57 


Estimated : 

November,  1914.  .$1,300.00 
December,   1914..   1,400.00    $2,700.00 


Excess  of  actual  over  estimated       $165.57 


During  the  course  of  the  work  on  the  engagement  there  will 
perhaps  have  been  made  a  list  of  matters  which  the  auditor  de- 
sired to  look  into  or  ask  questions  about.  These  notes  may  have 
been  made  on  a  sheet  of  journal  paper  or  any  piece  of  paper 
which  happened  to  be  convenient.  Such  lists  should  now  be 

161 


PRINCIPLES.  OF  AUDITING 

looked  over  carefully  to  make  sure  that  everything  is  clear ;  that 
everything  has  been  looked  up;  and  that  there  are  no  questions 
in  connection  with  these  memoranda  which  the  auditor  now 
wishes  to  ask. 

The  papers  and  books  should  be  returned  in  the  same  order 
in  which  they  were  received.  By  that  is  meant  that  they  should 
not  be  out  of  order,  scattered  about,  or  disarranged.  These  may 
seem  like  small  details  and  highly  theoretical.  As  a  matter  of 
fact  they  are  not.  They  count  for  a  great  deal.  If  papers  are 
received  in  a  certain  order  they  should  be  kept  in  that  order  if 
possible  and  not  disarranged.  They  should  be  given  back  in 
the  same  order  received  and  not  left  about  so  that  they  will  have 
to  be  hunted  up  by  the  client's  employes.  Some  judgment  will 
of  course  be  necessary  in  this  respect.  Papers  may  of  necessity 
have  gotten  out  of  order  and  it  may  be  to  the  advantage  of  the 
client  to  have  a  six  dollar  a  week  clerk  put  them  back  in  order 
rather  than  to  have  a  man  whose  services  cost  twenty-five  dol- 
lars a  day  do  the  work.  Under  such  circumstances  it  may  be 
better  to  go  to  the  person  from  whom  the  papers  were  received 
and  explain  the  situation,  arranging  accordingly  respecting  the 
matter.  The  thing  which  people  dislike  is  to  have  the  auditor 
leave  without  returning  the  papers  and  without  saying  anything 
about  it.  Psychology  plays  an  important  part  in  the  auditor's 
work.  It  operates  for  or  against  him  in  accordance  with  how 
he  uses  it.  A  man  will  probably  be  forgiven  for  bringing  back  a 
file  of  papers  which  are  disarranged  if  he  explains  and  apologizes 
for  the  condition  in  which  they  are  returned.  The  chances  are 
that  they  will  be  received  gracefully  and  the  matter  will  occasion 
little  disturbance.  If  they  are  thrown  on  someone's  desk  without 
any  explanation,  the  chances  are  almost  certain  that  the  impres- 
sion created  will  be  an  unfavorable  one.  Consequently  the  im- 
portance of  being  sure  before  leaving  that  everything  has  been 
properly  returned. 

It  is  worth  while  before  leaving  to  go  around  and  bid  the 
employes  with  whom  one  has  come  in  contact,  goodbye.  One 
should  not  be  afraid  to  shake  hands.  It  will  not  do  any  harm 
even  though  it  soils  one's  hands  occasionally.  To  grip  the  hand 
of  a  man  working  on  a  lathe  in  a  machine  shop  is  not  at  all 
beneath  the  dignity  or  position  of  the  auditor.  It  will  engender 
a  friendly  feeling  on  the  part  of  the  machinist  and  the  grease 

162 


HOW  TO  END  AN  AUDIT 

and  oil  will  come  off  later.  It  is  not  amiss  before  leaving  to  let 
the  employes  know  that  one  thinks  enough  of  them  to  bid  them 
goodbye  and  perhaps  say  a  word  to  the  effect  that  the  courtesies 
extended  by  them  have  been  appreciated. 

It  is  not  the  practice  to  write  the  report  in  the  office  of  the 
client  or  the  place  in  which  the  work  has  been  done.  The  auditor 
as  a  rule  gathers  his  material  and  returns  to  his  own  office  for 
the  preparation  of  the  report.  There  are  certain  arguments  for 
and  against  this  practice.  Better  reports  would  probably  be 
written  if  they  were  written  in  the  client's  office.  If,  under  such 
circumstances,  there  were  any  questions  arising  in  connection  with 
the  writing  of  the  report,  it  would  be  an  easy  matter  to  make  the 
inquiry.  If  any  questions  should  arise  requiring  reference  to  the 
books,  they  would  be  immediately  available.  No  matter  how  far 
ahead  one  thinks  or  how  carefully  one  plans  there  is  apt  to  be 
something  overlooked  or  something  which  has  not  been  provided 
for.  On  the  other  hand,  there  is  some  objection  to  preparing 
the  report  in  the  office  of  the  client  because  of  the  fact  that 
portions  of  the  report  as  it  is  being  prepared  might  be  overseen 
by  some  of  the  employes  of  the  client.  It  is  quite  natural  that 
the  auditor  should  develop  informal  acquaintanceship  with  cer- 
tain employes  who  might  in  stopping  to  chat  during  their  spare 
time,  look  at  the  papers  spread  out  before  the  auditor  and  see 
something  which  was  intended  to  be  conveyed  in  confidence  to 
the  client.  The  tendency  on  the  part  of  employes  is  to  be  curious 
as  to  what  the  auditor  is  putting  into  the  report.  If  the  report 
is  not  prepared  in  the  client's  office  this  opportunity  is  removed. 


163 


CHAPTER   XXIII 

WHAT  TO  Do  AFTER  AN  AUDIT 

It  should  be  understood  that  what  is  about  to  be  said  con- 
cerning reports  and  their  preparation,  is  not  laid  down  as  standard 
practice.  It  is  presented  merely  as  the  practice  which  has  come 
within  the  experience  of  the  author.  That  it  is  used,  however, 
by  one  of  the  largest  and  most  successful  firms  in  the  profession, 
should  give  it  sufficient  standing. 

After  returning  to  his  office  the  auditor  proceeds  with  the 
preparation  of  the  report.  The  report  is  prepared  first  in  the 
rough  by  the  man  who  has  charge  of  the  engagement.  That  is 
to  say,  he  writes  out  in  pencil  or  pen  and  ink  his  entire  report 
in  rough  form,  after  which  it  is  typed  in  the  rough. 

For  purposes  of  discussion  the  report  may  be  divided  into 
four  parts:  the  presentation,  the  certificate,  the  comments  and 
the  statements.  It  is  customary  to  prepare  the  statements  first, 
then  the  comments,  after  which  come  the  certificate  and  the 
presentation. 

Statements  are  prepared  first  in  the  rough  on  analysis  paper 
and  journal  paper.  They  may  be  divided  for  report  purposes 
into  two  classes:  exhibits  and  schedules.  Exhibits  are  usually 
prepared  on  analysis  sheets,  while  schedules  may  be  prepared  on 
journal  paper  or  analysis  paper  torn  in  two  so  that  it  will  be 
about  the  size  of  journal  paper.  The  exhibits  are  denoted  by 
letters ;  the  schedules  by  numbers,  and  both  exhibits  and  schedules 
are  marked  as  a  rule  at  the  bottom  of  the  page.  The  typical 
exhibits  are  the  balance  sheet,  statement  of  income  and  profit  and 
loss  and  sometimes  the  statement  of  cash  receipts  and  disburse- 
ments. These  exhibits  are  supported  by  schedules.  Where  there 
is  an  item  on  one  of  the  exhibits  in  which  it  is  desired  to  show 
the  details,  a  schedule  is  used.  The  balance  sheet,  for  example, 
will  be  marked  Exhibit  "A".  On  this  balance  sheet  there  may 
be,  for  example,  an  item — "land  and  buildings".  It  may  be 
desirable  to  show  the  details  of  the  item,  when  a  schedule  will 
be  used.  The  schedule  may  be  designated  "Schedule  showing 
details  of  land  and  buildings".  It  will  be  marked  at  the  bottom 
—"Exhibit  'A',  Schedule  No.  1".  The  statement  of  income  and 

165 


PRINCIPLES  OF   AUDITING 

profit  and  loss  will  usually  be  designated  as  Exhibit  "B".  Again 
there  may  be  occasion  for  supporting  some  of  the  items  by 
schedules.  The  profit  and  loss  charges  may  be  numerous  so  that 
instead  of  listing  them  all  in  the  exhibit,  it  will  be  preferable  to 
show  them  in  a  schedule.  Such  a  schedule  might  be  headed 
"Schedule  showing  details  of  profit  and  loss  charges".  It  would 
likewise  be  marked  "Exhibit  'B',  Schedule  No.  1." 

These  statements  will  be  made  up  from  the  working  sheet 
and  the  analyses  of  the  different  accounts  which  support  the 
working  sheet  together  with  the  adjustments  which  have  been 
made.  It  is  perhaps  at  this  time  that  the  novice  will  appreciate 
better  than  ever  before  the  practical  benefit  of  the  working 
sheet.  Starting  with  the  figures  on  the  client's  books,  any  changes 
or  adjustments  or  corrections  having  been  journalized,  if  these 
journal  entries  are  now  posted  to  the  working  sheet  in  the  adjust- 
ment columns,  the  figures  will  be  brought  into  shape  for  use  in 
the  report.  This  seems  to  make  the  work  very  complete.  It 
establishes  a  connection  between  the  two  sets  of  figures  and  saves 
the  auditor  all  anxiety  as  to  what  he  may  have  done  in  adjusting 
the  figures  on  the  client's  books.  Very  often  after  having  gone 
out  to  another  engagement,  since  as  a  rule  he  is  unable  to  remain 
in  the  office  until  the  report  is  typed  and  delivered,  the  auditor 
who  did  the  work  will  be  called  upon  to  explain  something  in 
connection  with  his  report.  Having  his  thoughts  centered  on  the 
work  in  which  he  is  at  present  engaged,  it  is  not  an  easy  matter 
to  shift  to  the  previous  set  of  working  papers  and  explain  immedi- 
ately just  what  was  done.  Possibly  six  weeks  after  the  report 
was  written,  someone  in  the  office  will  want  information  concern- 
ing it.  Sometimes  also  it  is  necessary  after  the  report  has  been 
rendered,  to  discuss  certain  phases  of  it  with  the  client  or  some 
of  his  representatives.  With  the  working  sheet  and  the  support- 
ing papers  properly  arranged,  the  auditor  has  no  difficulty  in 
answering  quickly  at  any  time,  any  questions  which  may  arise  in 
connection  with  the  report. 

In  making  rough  copies  of  statements  it  is  important  that 
they  should  be  written  exactly  as  they  are  to  be  copied.  Nothing 
should  be  left  to  the  imagination  or  intelligence  of  the  copyists. 
This  is  on  the  assumption,  of  course,  that  it  is  the  practice  to 
write  out  the  reports  and  have  someone  else  copy  them.  Such 
will  be  the  case  nine  times  out  of  ten.  These  copyists  make  what 

166 


WHAT  TO  DO  AFTER  AN  AUDIT 

they  call  "Chinese"  copies.  They  copy  just  what  they  see  and 
they  do  not  stop  to  think  whether  it  is  right  or  wrong.  They 
have  all  they  can  do  to  make  the  copy  exact.  Getting  the  proper 
spacing  is  not  the  least  difficult  part  of  their  work.  Conse- 
quently, if  one  wishes  to  have  words  like  furniture  and  fixtures 
spelled  out  in  the  typewritten  copy,  the  words  should  be  written 
that  way  in  the  rough.  If  the  abbreviation  "furn.  and  fix."  is 
used  in  the  rough,  it  will  be  typed  that  way  in  the  copy.  This 
may  not  of  course  be  invariably  true,  since  some  large  offices 
with  elaborate  report  departments  have  a  standing  rule  that  no 
abbreviations  are  to  be  used. 

Comments,  sometimes  referred  to  as  the  essay  section  of  the 
report,  have  four  main  purposes : 

First,  to  bring  sharply  to  the  attention  of  the  reader  a  par- 
ticular fact  which  might  be  passed  over  in  the  examina- 
tion of  the  statements. 

Second,  to  explain  or  make  clear  certain  figures  in  the  state- 
ments. 

Third,  to  describe  the  work  which  has  been  done  and  per- 
haps tell  what  has  not  been  done. 

Fourth,  to  present  criticisms,  suggestions,  or  recommenda- 
tions ;  the  latter  only  in  case  they  are  requested. 

As  an  illustration  of  the  first  point,  one  might  say — "It  should 
be  noted  that  the  figures  shown  in  the  report  are  in  this  particular 
the  correct  ones  and  not  those  which  appear  in  the  books  of  the 
client." 

In  the  same  way  in  connection  with  the  item — land  and  build- 
ings, for  example,  the  following  might  appear — "This  account 
represents  the  purchase  price  ($27,500)  and  improvements  and 
betterments  ($3,892.90)  of  the  property  known  as  Waverly 
House,  No.  38  West  Tenth  Street,  New  York  City."  It  might 
be  true  in  a  case  of  this  kind  that  both  the  purchase  price  and 
improvements  could  be  shown  in  the  balance  sheet.  If  that  idea 
is  followed,  however,  it  is  apt  to  lead  to  a  balance  sheet  which  is 
complicated  and  heavy  rather  than  one  which  is  neat  and  concise 
as  it  should  be.  Comments  therefore  offer  an  opportunity  of 
maintaining  the  statements  in  a  form  which  is  clean  and  concise, 
even  though  it  is  necessary  to  give  detailed  information  concern- 

167 


PRINCIPLES  OF  AUDITING 

ing  matters  of  this  kind.  In  connection  with  this  point  comments 
are  also  used  for  the  purpose  of  showing  details,  where  the  de- 
tails are  not  sufficient  in  number  to  warrant  the  preparation  of  a 
schedule.  As  an  illustration  of  this,  the  following  may  serve : 

Furniture  and  Fixtures  as  shown  in  Exhibit  "A" 

This  account  is  composed  of  the  following  items : 

General  office  in  Waverly  Place $1,500.00 

Employment  exchange 500.00 

Mental  work 525.00 

Extension  work 475.00 

Protective  league 800.00 


$3,800.00 

In  the  above  illustration  there  are  five  items.  It  would  not  be 
practicable  to  set  these  items  forth  in  the  balance  sheet.  It  is 
important,  however,  that  the  make-up  of  the  item  of  $3,800  as 
it  appears  in  the  balance  sheet,  should  be  explained,  or  the  de- 
tails shown  somewhere.  There  are  not  sufficient  items  to  war- 
rant the  preparation  of  a  schedule.  The  comments  therefore 
serve  admirably  to  bring  out  a  matter  of  this  kind. 

In  some  cases  the  auditor  desires  to  have  understood  precisely 
what  he  has  done  and  what  he  has  not  done.  He  may  say,  for 
example,  concerning  the  accounts  receivable — "I  have  tested  the 
accounts  receivable  by  checking  the  subsidiary  records  to  the 
controlling  account,"  or  "I  have  not  been  able  to  verify  com- 
pletely the  income  from  subscriptions  because  of  the  fact  that 
certain  of  the  records  were  missing  at  the  time  of  the  audit  and 
were  not  subsequently  produced." 

There  is  considerable  difference  of  meaning  among  the  words 
criticism,  suggestion  and  recommendation.  The  auditor  should 
never  hesitate  to  criticise  anything  in  connection  with  the  ac- 
counts or  the  accounting.  The  criticism  should  be  tactful  and 
above  all  constructive.  A  classic  injunction  of  one  of  the  leaders 
in  the  profession,  reproduced  without  the  profane  touch,  which 
it  must  be  admitted  gave  it  considerable  force  is,  "be  constructive 
and  not  destructive."  Fault  must  not  be  found  simply  for  the 
purpose  of  finding  fault  or  making  it  appear  that  the  auditor  is 
very  efficient.  Such  is  not  the  spirit  in  which  criticism  should 

168 


WHAT  TO  DO  AFTER  AN  AUDIT 

be  made.  It  is  a  part  of  the  auditor's  duty  to  point  out  where 
things  are  wrong.  He  should  not,  however,  do  this  unless  he  is 
in  a  position  to  say  also  what  should  be  done  to  correct  the  trouble 
or  improve  the  situation.  If  the  auditor  is  obliged  to  tear  down, 
he  should  have  something  ready  to  put  in  its  place. 

In  a  recent  engagement  a  payroll  book  was  found  in  which 
it  was  the  practice  to  write  each  month,  the  name  of  each  employe, 
with  the  amount  earned,  and  have  the  employes  sign  the  book 
at  the  time  of  receiving  their  wages.  There  were  about  fifty  or 
sixty  such  employes.  This  situation  offered  an  opportunity  for 
constructive  criticism.  The  client  was  told  that  the  practice  was 
not  a  good  one;  that  it  resulted  in  waste  time,  and,  furthermore, 
permitted  one  employe  to  find  out  what  others  received,  thereby 
giving  a  chance  for  gossip  and  the  breeding  of  dissatisfaction. 
The  criticism  was  followed  by  the  suggestion  that  there  be  intro- 
duced a  book  provided  with  columns  and  short  leaves  so  that  the 
name  of  each  employe  need  be  written  but  once  during  the  year, 
and  the  amounts  corresponding  to  the  respective  months  inserted 
in  the  appropriate  columns.  For  the  purpose  of  getting  a  receipt, 
a  printed  slip  was  suggested.  This  required  only  the  insertion 
of  the  date  and  amount.  The  client  saw  immediately  the  whole 
situation.  He  realized  that  the  criticism  was  just  and  that  some- 
thing better  had  been  offered  to  take  the  place  of  the  part  of  the 
system  criticised.  The  suggestion  was  immediately  adopted  and 
the  new  scheme  put  into  effect. 

Generally  speaking  recommendations  should  not  be  made 
unless  they  are  asked  for.  They  should  also  be  confined  to  mat- 
ters of  accounting.  There  is  no  warrant  for  the  recommendation 
by  the  auditor,  that  the  lighting  system  be  changed  because  the 
light  does  not  agree  with  his  eyes,  or  that  buildings  covering 
several  acres  be  torn  down  and  replaced  by  new  buildings  be- 
cause the  arrangements  with  regard  to  the  routing  of  goods  is 
not  ideal.  As  an  illustration  of  a  recommendation  which  was 
presented  in  response  to  a  request  on  the  part  of  the  client  for  any 
recommendation  which  might  seem  desirable,  the  following  is 
given: 

"Under  the  present  method  of  handling  commissions  the  cash' 
receipts  only  from  these  sources  are  taken  into  the  general  books. 
There  appears  to  be  no  control  of  the  journal  charges  for  these 
commissions.  It  would  seem  to  be  advantageous  to  show  upon 

169 


PRINCIPLES  OF  AUDITING 

the  books  the  commissions  at  the  time  they  were  earned;  that 
is,  at  the  time  of  placing  the  applicant  in  the  position.  This  plan 
would  also  establish  a  control  over  the  commissions  charged, 
which  it  is  believed  would  assist  the  bureau  in  handling  this,  the 
main  one  of  its  accounting  problems. 

"The  introduction  of  two  books  known  as  the  commission 
register  and  the  commission  discount  register  respectively  would 
provide  a  medium  for  carrying  out  the  work  as  above  suggested." 

Rulings  for  these  books  were  then  submitted  to  the  secretary. 
This  could  not  have  been  done  with  propriety  unless  the  person  in 
authority  had  said — "We  shall  be  glad  to  have  you  make  any 
recommendations  or  point  out  anything  that  occurs  to  you  as 
being  possible  of  improvement." 

Care  should  be  observed  as  to  the  tone  of  the  comments. 
Above  all  things  they  should  not  give  offense.  Care  should  be 
observed  as  to  what  is  said  and  how  it  is  said  so  as  not  to  incur 
the  illwill  of  any  person  who  reads  the  report  or  is  affected 
thereby.  Remarks  should  not  be  abrupt  or  unduly  frank.  They 
should  be  tempered  and  not  made  too  harsh.  This  does  not  mean 
that  the  truth  as  one  sees  it  may  not  be  told.  There  are  two 
ways  of  saying  things.  One  may  point  to  a  light  and  say — "That 
is  an  indirect  light,"  or  it  may  be  put  in  a  different  way,  namely, 
"That  appears  to  me  to  be  an  indirect  light."  The  latter  has  ac- 
complished the  same  purpose  as  the  former.  Attention  has  been 
directed  to  the  light  which  was  the  object  of  the  remark.  If  the 
positive  statement  that  the  light  in  question  is  an  indirect  one  is 
made,  it  may  be  possible  that  someone  whose  attention  is  directed 
to  the  light  will  be  an  engineer  who  will  challenge  the  remark 
and  take  the  speaker  up  on  a  technicality  and  prove  that  it  is  not 
an  indirect  light.  It  is  well  for  the  auditor  never  to  make  a 
statement  which  he  cannot  prove.  It  is  better  to  qualify  one's 
remarks  unless  one  is  absolutely  sure  of  the  facts  and  ready  to 
prove  them  in  court  if  necessary.  These  points  are  illustrated  by 
the  following  extract  from  a  recent  report : 

ENDOWMENT  FUND  INVESTMENTS 

The  following  securities  comprise  the  endowment  fund: 
"The  above  securities  with  the  exception  of  the  two  guarantee 
mortgages  were  verified  by  examination  at  the  safe  deposit  vaults 
of  the  Broadway  Trust  Company  at  Eighth  Street."    The  mort- 
gages of  Sampson  &  Hendricks  were  at  the  time  of  the  audit  de- 

170 


WHAT  TO  DO  AFTER  AN  AUDIT 

posited  with  the  Title  Guarantee  and  Trust  Company  as  security 
for  a  note  of  $4,923.86  and  were  verified  by  correspondence  with 
the  Trust  Company. 

"The  authorization  of  the  treasurer  to  deposit  these  endow- 
ment fund  securities  as  collateral  for  a  loan  was  given  by  the 
board  of  trustees  as  reported  in  the  minutes  of  November  20. 
1914,  as  follows:  'On  motion,  it  was  resolved  that  the  treasurer 
of  the  Bank  Organization  be  hereby  authorized  to  dispose  of 
investments  and  sell  securities  of  this  corporation  to  the  amount 
of  $4,923.86  for  account  of  building  fund,  and  hereby  is  authorized 
to  borrow  the  said  amount  from  the  Title  Guarantee  and  Trust 
Company  upon  the  guaranteed  mortgages  held  by  this  corporation 
pending  an  opportunity  to  dispose  of  same  to  advantage.' 

"While  therefore  the  pledging  of  the  securities  has  the  ap- 
proval of  the  board  of  trustees,  the  moral  aspect  of  hazarding 
the  endowment  fund,  by  pledging  securities  representing  it,  for  a 
loan  is  perhaps  unquestionable,  since  such  procedure  might 
amount  to  a  conversion  of  the  endowment  fund  to  current  pur- 
poses. It  is  in  the  opinion  of  the  auditor  desirable  that  the  en- 
dowment fund  be  analyzed  with  regard  to  the  endowments  which 
were  intended  by  the  donors  to  be  of  a  permanent  character  and 
those  which  were  not,  and  that  in  accordance  with  such  classifica- 
tion, the  amount  of  the  permanent  fund  be  fixed  by  the  board  of 
trustees  with  the  idea  of  preserving  it." 

What  had  happened  in  this  case  was  that  securities  which  were 
a  part  of  the  endowment  fund  had  been  deposited  as  collateral 
for  a  loan  to  the  building  fund.  If  anything  had  happened  that 
the  loan  could  not  have  been  paid,  the  securities  would  have  been 
sold  and  it  would  have  been  equivalent  to  converting  securities  of 
the  endowment  fund  to  the  building  fund. 

The  handling  of  this  matter  in  the  comments  required  a  great 
deal  of  tact.  No  offense  was  given,  but  no  doubt  was  left  in 
anyone's  mind  as  to  what  was  thought  regarding  the  situation. 
The  facts  were  pointed  out  in  a  forceful  but  inoffensive  way, 
and  the  remedy  for  removing  any  suspicion  of  error  or  moral 
negligence  was  suggested.  As  near  as  could  be  ascertained  none 
of  these  funds  were  legal  trusts.  They  were  funds  which  had 
been  given  in  one  form  or  another  by  persons  who  had  asked 
that  they  be  set  aside  for  special  purposes.  The  board,  it  was 
said,  felt  that  since  certain  of  the  assets  had  been  put  into  the 
fund  arbitrarily  by  action  of  the  board,  nothing  wrong  was  being 
done  when  the  securities  were  taken  out  of  the  fund.  The  state- 
ment was  not  made  that  the  members  of  the  board  were  legally 

171 


PRINCIPLES  OF  AUDITING 

liable  or  that  they  were  guilty  of  any  illegality  in  what  they  did. 
It  looked,  however,  on  the  surface  as  if  they  were  converting  funds 
and  using  them  for  the  purpose  other  than  that  for  which  they 
were  intended.  The  comments  in  the  case  in  question  instead  of 
giving  any  offense,  resulted  in  doing  exactly  what  was  suggested. 
The  feeling  remained  a  friendly  one.  The  board  felt  that  it  had 
been  criticised  but  that  the  criticism  was  a  constructive  one  and 
had  been  made  in  an  inoffensive  manner. 

It  is  desirable  as  a  rule  that  the  impersonal  form  be  used  as 
far  as  possible.  Instead  of  using  "we  think,"  it  seems  better 
to  say  "it  is  thought."  Of  course  it  sometimes  happens  that  the 
personal  form  will  be  desired,  since  the  phrase  "in  our  opinion" 
is  frequently  seen  in  certificates.  Such  expressions  as  "your  com- 
mittee," "your  treasurer,"  etc.,  are  not  good  form.  It  is  better 
as  a  rule  to  use  the  title  of  the  position  which  the  person  in  ques- 
tion occupies.  As  far  as  possible  the  mentioning  of  names  should 
be  omitted.  Instead  of  saying  "Mr.  Foote  told  us  so  and  so,"  it  is 
better  to  say  "Upon  information  from  the  secretary,"  or  "it  is 
understood  from  the  secretary." 

In  writing  the  comments  it  is  considered  good  practice  to 
follow  the  order  in  which  the  items  appear  in  the  statements.  In 
beginning  it  may  be  necessary  to  write  an  introductory  para- 
graph, but  immediately  following  the  various  matters  should  be 
discussed  in  the  order  in  which  the  items  to  which  they  relate, 
appear  in  the  statements.  In  accordance  with  this  rule,  land  and 
buildings  is  usually  the  first  item  to  receive  attention. 

Good  construction  advocates  the  use  of  simple  words,  short 
sentences  and  non-technical  expressions  as  far  as  possible.  By  so 
doing  someone  may  be  bored,  but  it  is  much  better  to  use  language 
which  the  ordinary  man  understands  rather  than  to  attempt  to 
impress  readers  with  literary  style.  It  is  not  necessary  to  indulge 
in  literary  style.  All  that  is  required  is  to  express  such  thoughts 
as  a  person  may  have  in  connection  with  a  technical  subject  in  a 
clear,  concise  way  which  the  layman  will  understand.  The  pro- 
fessional auditor  is  not  expected  to  be  a  literary  expert.  He  is 
expected  to  have  an  accounting  sense  and  to  understand  account- 
ing, and  to  be  able  to  use  English  sufficiently  well  to  express 
clearly  what  he  has  to  say  on  the  subject. 

Before  taking  up  the  subject  of  the  certificate,  it  is  probable 
that  some  consideration  should  be  given  to  the  object  thereof. 

172 


WHAT  TO  DO  AFTER  AN  AUDIT 

A  person  would  not  think  of  building  a  house  without  engaging 
an  architect.  This  is  because  of  lack  of  technical  knowledge  of 
materials  and  construction  work.  An  architect  is  skilled  in  such 
matters  and  accordingly  there  is  confidence  in  his  judgment  He 
is  engaged  to  draw  the  plans  and,  in  most  present-day  cases,  to 
supervise  the  construction  work.  In  the  same  way  a  lawyer  is 
engaged  where  legal  matters  are  involved.  Not  understanding 
the  law  nor  being  skilled  in  its  practice,  a  person  is  unable  as  a 
rule  to  defend  himself.  If  he  becomes  involved  in  a  legal  action, 
the  layman  is  not  supposed  to  know  anything  about  the  technique 
concerned  with  the  preparation  and  trial  of  a  case.  Such  is  the 
business  of  a  lawyer.  Being  skilled  in  these  matters,  one  has 
confidence  in  his  judgment  and  feels  that  he  will  extend  the 
proper  advice  and  care  of  the  interest  involved.  In  precisely  the 
same  way  should  the  relation  existing  between  client  and  ac- 
countant or  auditor  be  looked  upon.  Generally  speaking,  the 
client  knows  little  about  accounts  or  accounting.  To  him  their 
philosophy  or  theory,  their  treatment,  and  interpretation  is  at 
least  far  from  being  thoroughly  understood.  He  may  employ  an 
accountant  to  do  this  work  for  him.  Not  knowing  whether  the 
statements  are  correct  or  incorrect,  or  what  they  mean,  he  puts 
his  case  into  the  hands  of  the  auditor  who  is  skilled  in  accounts 
and  accounting  as  a  result  of  training  and  experience,  for  the 
purpose  of  obtaining  his  opinion  as  to  the  accuracy  thereof.  It  is 
a  technical  matter  of  which  most  clients  are  not  competent  to 
judge,  and  an  auditor  is  employed  to  represent  the  client  and 
advise  him  as  to  the  results.  The  object  of  a  certificate  then  is  to 
obtain  from  an  unbiased  person  who  is  skilled  in  the  matter  of 
accounts  and  accounting,  an  opinion  as  to  their  accuracy. 

Certificates  are  of  two  forms.  One  is  known  as  the  short 
form;  the  other  the  long  form.  The  following  is  a  specimen  of 
the  short  form : 


PRINCIPLES  OF  AUDITING 

THE   WARBURTON    DESK   COMPANY 
CERTIFICATE 


We  have  made  an  audit  of  the  accounts  of  the  Warburton 
Desk  Company  for  the  year  ended  December  31,  1914,  and 

WE  HEREBY  CERTIFY  that  the  accompanying  General  Balance 
Sheet  and  Statement  of  Income  and  Profit  and  Loss  are  correct, 
and,  in  our  opinion,  subject  to  the  accompanying  comments,  set 
forth  the  true  financial  condition  and  result  of  operations  respec- 
tively  on  said  date.  JoNES  &  PARKER) 

Certified  Public  Accountants. 
New  York,  March  20,  1915. 

It  should  be  noted  that  the  certificate  may  take  the  form  of  a 
separate  sheet  or  appear  at  the  bottom  of  the  balance  sheet.  In 
the  latter  case,  the  wording  would  need  to  be  changed  a  trifle  so 
as  to  read  "the  above  balance  sheet  and  accompanying  statement 
of  income  and  profit  and  loss,  etc." 

The  long  form  which  follows  is  taken  from  a  semi-public 
report  and  is  that  of  a  firm  of  certified  public  accountants.  It 
appears  as  sent  out,  except  that  the  names  have  been  changed. 

THE   AMITY   MANUFACTURING   COMPANY 
CERTIFICATE 


We  have  audited  the  books  and  accounts  of  The  Amity  Manu- 
facturing Company  for  the  year  ended  October  31,  1914;  we 
have  verified  the  cash  and  notes  receivable  and  checked  the  prices 
and  calculations  of  the  inventories  on  hand  taken  by  the  com- 
pany's employes ;  we  have  tested  the  accounts  receivable  by  check- 
ing the  subsidiary  records  to  the  controlling  account  and  believe 
that  the  reserve  provided  for  doubtful  accounts  is  sufficient  to 
meet  the  losses  which  may  be  sustained  in  the  collection  thereof. 
The  other  reserves  provided  are  believed  to  be  sufficient  for  the 
purposes  for  which  created,  and 

WE  HEREBY  CERTIFY  that,  in  our  opinion,  the  accompanying 
General  Balance  Sheet  as  of  October  31,  1914,  and  Statement  of 
Income  and  Profit  and  Loss  for  the  year  ended  that  date  are 

correct-  (Signed) 

STREET  &  BROWN, 

New  York  Certified  Public  Accountants. 

November  27,  1914. 

174 


WHAT  TO  DO  AFTER  AN    AUDIT 

The  above  certificate  is  sometimes  referred  to  as  a  qualified 
certificate.  Very  often,  however,  the  qualifications  are  of  a  nega- 
tive character  instead  of  positive  as  above.  Some  time  the  certifi- 
cate reads :  "We  have  not  inspected  the  securities,"  or  "We  have 
not  verified  the  inventories  in  accordance  with  the  understanding 
with  the  secretary  of  the  company  to  the  effect  that  we  should 
not  do  so." 

While  it  is  not  the  intention  to  enter  into  a  lengthy  discussion 
of  the  merits  and  demerits  of  the  two  certificates,  one  thing  should 
be  pointed  out.  The  first  certificate  shows  that  the  statements 
are  correct  and  set  forth  true  financial  condition,  etc.  The  second 
one  shows  only  that  the  statements  are  correct.  While  it  is  per- 
haps the  intention  to  imply  in  the  latter  case  that  the  statements 
show  financial  condition  and  result  of  operation,  the  fact  is  not 
so  stated.  Apparently  the  statement  might  be  correct  according 
to  the  books  while  the  books  might  not  show  true  financial  con- 
dition. This  form  of  certificate  has  been  criticised  considerably 
in  this  respect.  Lawyers  have  given  the  opinion  that  the  second 
certificate  would  not  have  as  much  value  to  the  client  at  law  as 
the  first.  It  has  been  suggested  that  the  testimony  of  the  account- 
ant signing  the  second  form  of  certificate  would  not  have  as 
much  weight  in  court  as  if  the  first  form  had  been  used. 

One  thing  seems  certain  that  if  an  auditor  is  to  occupy  the 
proper  position  in  the  business  field,  that  of  high  professional 
standing,  and  be  well  compensated  for  his  services  he  must  accept 
a  certain  amount  of  responsibility  for  the  work  which  he  does. 
To  do  work  as  an  auditor  and  accept  money  for  it  without  the 
corresponding  responsibility  seems  neither  fair  nor  ethical.  If 
such  things  take  place,  the  profession  instead  of  being  elevated 
to  a  high  plane,  will  degenerate  into  a  money  grabbing  vocation. 

The  presentation  consists  of  a  letter  typed  on  the  business 
stationery  of  the  auditor,  submitting  the  report.  It  serves  in  a 
way  as  an  index  to  the  report,  since  it  sets  forth  and  describes 
the  exhibits  and  schedules.  The  presentation  is  usually  the  last 
part  of  the  report  to  be  prepared,  but  occupies  the  first  position 
when  the  report  is  made  up.  The  main  parts  into  which  the 
report  is  divided  are  arranged  as  follows :  presentation,  certificate, 
comments,  statements.  A  specimen  presentation  will  be  found 
on  page  179,  followed  by  other  specimen  parts  of  the  report. 

As  to  the  form  which  a  report  shall  take,  there  is  a  choice  of 

175 


PRINCIPLES  OF  AUDITING 

top  or  side  binding.  Where  the  top  binding  is  used  the  single 
sheets  are  inserted  in  the  fold  of  the  cover,  punched  through  and 
strapped  or  otherwise  fastened.  The  report  in  this  form  may  be 
folded  if  desired.  The  other  form  is  bound  on  the  side.  Single 
or  double  sheets  may  be  used,  the  single  sheets  preferably,  be- 
cause of  the  fact  that  if  mistakes  are  made  on  double  pages,  the 
entire  page  has  to  be  rewritten.  If  single  sheets  are  used  the 
possibility  of  rewriting  is  reduced.  The  sheets  are  inserted  into 
the  cover  and  fastened  at  the  back  with  wire  staples  or  cloth 
fasteners.  In  such  form  the  report  may  be  opened  and  read  as  a 
book. 

In  typing  the  report  it  is  customary  to  make  six  copies ;  that 
•  is,  an  original  and  five  carbons.  This  is  in  order  that  one  copy 
may  be  used  for  proving  purposes,  another  for  the  file  and  four 
copies  for  the  client  if  required.  Sometimes  clients  will  desire 
two  copies  and  sometimes  three.  This  leaves  one  as  a  margin  in 
case  an  additional  copy  is  required  later.  While  the  report  is 
being  typed  it  is  easier  to  make  more  copies  than  are  required 
than  to  be  obliged  to  re-type  the  entire  report. 

The  report  department  does  the  comparing,  the  proving  and 
checking  of  figures  and  the  checking  of  references.  The  report 
is  first  prepared  in  the  rough  and  then  written  on  the  typewriter 
by  the  copyists.  After  being  typed  it  is  compared  with  the  rough. 
As  far  as  possible  all  figures  are  proven.  Any  additions,  sub- 
tractions, multiplications,  divisions,  percentages  or  rates  are  care- 
fully gone  over.  Wherever  figures  appear  which  may  not  only 
be  checked  but  proven,  such  proof  is  obtained.  Wherever  figures 
appear  in  the  comments  they  are  checked  to  the  statements  in 
order  to  be  sure  that  the  accountant  in  writing  the  comments  has 
not  made  mistakes  in  setting  down  the  figures. 

The  last  step  in  so  far  as  the  auditor  is  concerned  is  not  the 
least  important.  It  consists  of  putting  the  papers  away.  The 
analyses,  the  sheets  showing  details  which  support  the  trial  bal- 
ance, will  have  been  numbered.  These  numbers  should  appear 
on  the  trial  balance  on  the  line  with  or  in  front  of  each  corre- 
sponding account.  The  amount  shown  by  the  analyses  should 
agree  with  the  amount  shown  in  the  trial  balance.  If,  for  example, 
it  becomes  necessary  later  to  look  at  the  items  making  up  the 
account  "land  and  buildings,'"  reference  may  be  had  to  the  trial 
balance  where  finding  the  reference  to  be  No.  1,  analysis  sheet 

176 


WHAT  TO  DO  AFTER  AN  AUDIT 

No.  1  may  be  located  when  the  information  will  be  available.  The 
trial  balance  should  be  folded  into  which,  arranged  in  numerical 
order,  the  analyses  should  be  inserted.  All  miscellaneous  papers 
or  scraps  of  papers  should  be  saved  and  inserted  in  the  trial 
balance.  On  top  of  the  trial  balance  should  be  placed  the  rough 
statement  and  report  and  a  copy  of  the  finished  report.  All  this 
should  then  be  inserted  in  a  stiff  paper  folder,  writing  on  the 
outside  of  the  folder  the  title  of  the  engagement  and  the  period 
covered.  The  papers  may  then  be  left  with  the  satisfaction  of 
work  well  done  and  the  feeling  that  no  matter  who  happens  to 
refer  to  the  papers  in  the  future  everything  will  be  found  in  order. 

[FINIS] 


PRINCIPLES  OF  AUDITING 


CSITERIOK  MMTCTACtOSIIKL  COUPAJY 


REPORT 

OH  AUDIT  0V  TBS  ACCOOTT8 
FOR  THX  YXAR  ETOBD  9XCEKBZR  31, 


178 


WHAT  TO  DO  AFTER  AN   AUDIT 


J&HN    R    WILOMAN 
OK     •»    T     I     PICO 


Hew  York.  Karon  20,  1915. 
Mr.  sills  R.  Reed, 

President,  criterion  Manufacturing  Company, 

165  Broadway,  Sew"  York. 
Dear  Sir: 

in  accordance  witn  engagement,  I  oar a  made  an  audit  of  tne 
accounts  of  tne  Criterion  Manufacturing  Company  for  tne  year  ended 
December  31,  1911,  and  sutnit  nerewitn  a  certificate,  fire  pages  of 
comments,  and  tne  following  exhibits  and  schedule: 

EXHIBIT 

•A*     -     OXHIRAI,  BJUJUCE  SHEET  -  DSCEMBEH  31. 

Schedule 

tl  -  Statement  of  Irwestments  la 
bonds  of  kindred  companies. 

•B"     -     8IATSMEHT  Of  IHCOKK  AMD  ?R07IT  k  LOSS 

FOR  tfflt  YIAfl  mXD.DXCKKBBR  31.   191<». 

Toura  truly, 


Certified  Public  Accountant. 


179 


PRINCIPLES  OF   AUDITING 


W       V  O   »   I 


CIRTiriCATK 


I  have  made  an  audit  or  the  accounts  of  the  Criterion 
Manufacturing  Company  for  the  year  ended  Deoei&er  31,  191*, 
ant 

I  HEREBY  CXRTIjr    that  the  accompanying  General  Balance 
Sheet  and  statement  of  Income  and  Profit  ft  Loss  are  correct , 
an4  In  my  opinion,   subject  to  the  aacompanylng  commentB,  set 
forth  the  true  financial  condition  and  result  of  operations 
respectively  on  said  date* 


f      /Certified  Putollo  Aocount«at. 


Tori, 
March  20.  1915. 


1 80 


WHAT   TO  DO  AFTER   AN    AUDIT 


cottons  01  TUX  AOTIT 

XOB  1SE  YXAJL  Z8DD  IICZME2R   ii. 


FSQURJY  ACT  MAST 

Tbe  f  Igure  at  wnlcn  tneea  assets  are  snowa  in  tie  balance  sheet  is 
tnat  at  ttlcn  the  property  was  appraised  then  taken  over  fro*  tH«  fin 

Of  LSJBOa  ft  Bigg  1»S. 

RB&EIVABU  ACCOXiCODATIQB 


Tblfl  itea  r«prM«iti  notsfl  of  tae  fatlon&i  Produete  Copany  tear- 
ing lnt«r«it  at  Six  par  cent.        Th«e«  note*  wera  taken  fro*  tne  4bov« 
company  and  fllacounted  for  tlu  purpoat  of  supplying  (8M  wltn  current 
funds,      Tae  notes  will  nature  Jtne  >o,  1915*      Tbey  are  set  up,  witn 
tbe  contra,  In  order  to  show  tne  contingent  liability  of  Utt  Criterion. 
Manufacturing  Company. 

ACCOUNTS 


the  trial  balance  of  tae  customers'  ledger  vas  cteoiced  and  tne 
ledger  agreed  vitb  tne  controlling  acaount.      tne  individual  fiaianees 
were  not  oonflrmed  owing  to  the  objection  raised  by  tne  oonpany  wlt& 
regard  to  the  sending  out  of  stateaents. 

CZMMAL 

The  practice  of  the  company  in  the  Handling  of  reaittanoas  re- 
ceived through  the  call  is  open  to  soae  crltlolM.      At  the  t  las  of  tae 
audit,  checks  received  in  tne  nail  were  being  tamed  orer  inaedlately 
to  the  customers'  ledger  bookkeeper  to  be  credited  to  the  IndiTiaial  j 
accounts  affected  after  which  they  were  entered  In  tne  eaan.      ran  It 
was  explained  was  because  checks  are  frequently  wrong  in  aaount  and 
hare  to  be  returned,  or  held  pending  correspondence  concerning  then, 
This  practice  should  be  discontinued.      The  checks  should  be  first 
entered  in  the  cash  in  order  that  proper  control  cay  be  established  and 
•alatalned.      subsequently  the  checks,  or  preferably  a  realttanae  sheet, 
•ay  be  given  to  the  bookkeeper  for  posting  purposes*      All  checks  should 
be  deposited  as  soon  after  receipt  as  possible. 

'age  1. 


181 


PRINCIPLES  OF  AUDITING 


CRITERION 


COMPAJfy 


GKMKRAL  BALAKCE  SHEET  -  DECEMBER  31  1  191U 


ASSETS 

PROPERTY  AMD   PLAHT: 

Land,  ......................................  I   10,000.00 

Buildings  ,  .................................  50  ,000  .00 

Machinery  and  equipment,  ...................  65,000.00 

Automobile  trucks,  ...........  ..............  8,000.00 

Total  property  and  plant,  .................  .  $133,000.00 

IKVESTHSHTS  -  BONDS  0?  KI5DRSD  COMPANIES  -  Schedule  #1 
(  par  value  )  ,  ............................................    Wf,500;oo 

WORKING  AHD  TRADING  ASSETS: 

Raw  material,  ..............................  $  38,000.00 

worK  In  process  ,  ...........................  22  ,000.00 

Finished  goods,  ...........................  .  57,000.00 

Total  working  and  trading  assets,  ......  ....      117,000.00 

CUHRXNT  ASSETS: 

cash  In  hand  and  on  deposit,  ...............  4  1^|500.00 

Accounts  receivable,  ........  .....  ..........  195)300.00 

notes  receivable,  ..........................  10,200.00 

Holes  receivable  accommodation  (see  contra)  1^.500.00 

Total  current  assets,.  ......  .......  .  .......   23^,500.00 

DETERRSD  CHAROB9  TO  1XFKB8Z: 

Unexplred  insurance  premium,  ...............  $         500.00 

Mercantile  agencies  fees,  .................  .  200.00 

Warehouse  charges  prepaid......  ............  300.00 

Total  deferred  charges  to  expense  ..........  1,000.00 

TOTAL  ASSETS,  .........................     $530.000.00 


IXHIBIT   "A" 


182 


WHAT  TO  DO  AFTER  AN  AUDIT 


CHITBRIOg  UAHUFACTUBiyQ  COMPANY 
OEffERAL  BALANCE   SffltgT  -  DECEMBER  31,    191» 


LIABILITIES 
A  HP   C  A  P  IT  A  L 

CAPITAL  STOCK  -  2,000   SHARES  07  $100.00  EACH,  .............      $200,000.00 

RIAL  ESTATE  BOND  AHD  HORTOA01  ,  ............................  HO  ,000.00 

CURRENT    LIABII.1TIB3: 

Salaries  and  wages  accrued,  ................  $  2,500.00 

Accounts  payable,  ..........................  53,000.00 

Setae  payable,  ...............  ..............  62,000.00 

HoteS  receivable  accommodation  discounted 

(see  contra),  ............................  if,  500.  00 

Dividends  declared  ,  ........................  »K),000.00 

Total  current  liabilities,  .................   178,000.00 

RESERVES: 

Depreciation  of  buildings,..  ...............  I  5,000.00 

Depreciation  of  machinery  and  equipment,...    13,000.00 
Depreciation  of  automobile  trucks,  .........     3,200.00 

Contingencies,  .............................     5tOOO.QO    ^ 

Total  reserves,  ............................    26,200.00 

room  &  LOSS  SURPLUS  -  EXHIBIT  *B*.  ..............  .  .......       91,800.00 


TOTAL  LIABILITU8  A5D  CAPITAL, 


MBIBIT   "A* 


183 


PRINCIPLES  OF  AUDITING 


0?   UVZSTHKrTS   IB  £0X1)8  07  ETOHED  COMPAJH2S  - 


Alliance  Hanufactttrlng  Company,  ff  Bonds, 

flue  1925,  Interest  payable  January  ana  July  - 

par  value......  ......  ...  ...........  .......     $10,500.00 

Affiliated  Manufacturing  Company,  ~rjt  Bonds, 
«ue  1920,   interest  payable  January  and 
July  -  par  value,  .....  .  ...................       10,000.00 

rational  Products  company,  6#  Bond*,  due 
1915,  Interest  payable  January  aad  July  - 
par  value,  ......................  ...  .......         4,000.00 

American  Company,  6$  Bonds,  due  1928, 
Interest  payable  January  and'  July  *  par 
value......  ................  :  ..............       12,500.00 

Consolidated  Trading  company,  6$  Bonus,  due 
1917,  Interest  payable  January  and  July  - 
par  value  .....  ........................... 

TOTAL 


184 


WHAT  TO  DO  AFTER  AN   AUDIT 


CRITTOIOH  MAgOTACTUHnTQ  COMPANY 


eTATUOKT  OF   INCOME  AND  PROIIT  i  LOSS 
FOR  THE  YEAR  ENDED     DECEMBER  31 .   1911 


SALES  .....  .  ..............................................  ,     $750,682.90 

LESS  -  RETURH8,...  ........................................  1.560.88 

NET  SALES,  .........................  .......................     4749,122.10 

DEDUCTIOH8  FROM  SALES: 
Allowances,  .................  ............  ...    $        1*28.00 

Outward  freight  ana  cartage,.  .....  .........    _    6.015.32 

Total  .................................          6  .443.  32 

INCOME  PROM  SALES,  ........................................     $712,678.78 

MANUFACTURING  COST  0?  GOODS   SOLD: 

Purchases  of  raw  materials,,  ........  .  .......  4265,  826.  48 

Inward  freight  and  cartage,  ................  ^  5.820.00 

Total,  ..............  $271,646.1*3 

Add  -  Decrease  in  Inventory  of  raw  material    3,842.  6$ 


Direct  labor,...........*..  .........  .-  ......      197,823.32 

superintendence  ......  .  .......  .  .........  ....         2,478.23 

Factory  office  salaries,  ...................          7,859.65 

Heat,  light  ana  power,*.  .........  •  .........       25,800.00 

Factory  euppllee,  .....  .  ....................        15,306.50 

Factory  expense  ......  ......................         5,3*50.73 

Factory  repairs,  .....  ......  ................         3,181.00 

Depreciation  of  operating  'equipment,......*         6.500.00 

4539,818.62 

Deduct  -  Increase  In  Inventory  of  goods  In 
process  ,....  .....  ....  .......  •  .....  •  .....  •         5.  600.00 

Total  manufacturing  cost,  .....     $534,218.62 

Add  -  Decrease  In  Inventory  of  finished 
goods,  .....  ..  ...........................  .          2.  628.QQ 

Total  manufacturing  cost  Of  goods  eold      536.8^62, 
GROSS  PROFIT  OK  BALX8,  .................  .*  ......  .  ......  ....     |205,832.l6 

SELLING  EXPENSE: 

salaries  of  sales  manager  and  clerks,  .....  *  4  15,900.00 

Salaries  of  salesmen........................  10,000.00 

Salesmen's  commissions,  ....................  37,*3'*..70 

Traveling  expense,....  .......  ..............  6,743.47 

Advertising,  ...............................  i¥.io5.^ 

Total,  .............................  ...  _  8».18it.^l 

SELLING  PROFIT  -  (Forward),.  .............  .  ................     I121.6JM.05 


EXHIBIT,  «f"          <  continued )  -  l. 


PRINCIPLES  OF  AUDITING 


CRITXRIOK  lUIUFACTURnrO  COKPAIT. 

STATMonrr  01  nrcoia  AJCD  PROJIT  *  LOSS. 


SELLIHQ  PROFIT  -  (Forward) |1&1, 6W.05 

ADKISI STRATI VI  KPE5SS: 

Salaries  of  off  Icere, I  25*000.00 

Salaries  or  clones 17,850.55 

stationery  and  printing, ..          4,6>«).oo 

Postage,, £,800.00 

Telephone  and  telegrapa, 1, 14-75. 89 

General  expense, 5.6H8.00 

Total, >7_.»l».jfr_ 

•XT  PROTIT  OK  SALZS  -  IVCOKE  JTROM  OPKATIOH8, ft  6V, 233.61 

OTBXR  IKCOICC: 

income  from  securities, »•     |     2,770.00 

Interest  on  notes  receivable...............  4-10.00 

Casfc  discount  on  purchases,.,.... 916. 63 

Total ». 096.93 

TOTAL  IXOOUI 4  68,330. H* 

DBDUCTIOH8  FROM  IHCOKJ: 

Interest  on  tond  and  mortgage  payable, |  2,000.00 

Interest  on  notes  payable, .................    3,100*00 

Casb  discount  on  sales, ....................    3,285*76 

Insurance ,...:............ 1, 000. 00 

Taxes,.,.. 859.90 

Total t r    ^.0.2^5.76 

KBT   IKCOJffl  -  PBOm  ft  L088,. |  58,094.38 

PROFIT  *  LOSS  CREDITS: 
Profit  on  purchase  of  Consolidated  Trading 

3onpany  6$  Bonds |        300.00 

Profit  on  purchase  of  national  Products 

Company  6j(  Bonds, 160.00 

Total, '..  H60.QO 

PR07IT  A  LOSS  -  GROSS   SURPLUS  JOB  1KB  PBUOD, $  58,551.38 

PROFIT  It  LOBS  CHARG13: 
Provision  for  depreciation  of  buildings,...    |    2,500.00 

Provision  for  contingencies,... 2.500.00 

Total.... ,      5.000.00 

•PROFIT  Jb  LOM  TOR   THI  PIRIOD,. $   53.55A.38 

PROFIT  ft  LOSS  SURPLUS  AT  KSGIKN ISO  0?  PSRIOD , 78.2^5.62 

PROFIT  ft  LOSS  SURPLUS  BIFORI  CZDOCTIIO  DIVIDKSD8 $131,800.00 

DIVIDBHDS  B1CURID, T    ItO.OOO.OO 

PR07IT  ft  LOSS  SUglLDS,   DSQJQBJR  31,    1911*,.... i  91.800.00 


(Concluded)  .-• 


186 


INDEX 


ABSTRACT  QF  POSTINGS,  94,  106 
ACCOUNTABILITIES,  14 
ACCOUNTANCY,  i,  2 
ACCOUNTANT  : 

Apprenticeship  of,  20 

Conduct  of,  28,  29 

Designation  of  his  work,  16 

Engagement  of,  18,  19 

Instructions  to  a  young,  21 

Supplies  of,  22,  25,  27 

Working  conditions  of  an,  29,  30 
ACCOUNTING,  i,  2,  4,  13,  53,  121,  173 
ACCOUNTS  : 

Advertising,  146 

Aging  of  the,  138-141,  154 

Asset,  121 

Bank,  78 

Capital  stock,  155,  156 

Care  in  carrying,  55 

Cash,  55 

Charge  sales,  156 

Commissions  earned,  157,  158 

Controlling,  56,  103,  112,  153,  168 

Coupon  deposit,  152 

Creditors'  ledger,  67,  68,  69,  103, 
106",  153,  154 

Customers'  ledger,  67,  68,  69,  74, 
I3S-I40 

Discount  on  bonds,  145 

Dividends   declared   and   unpaid, 
152 

Exchange,  158 

Expense,  27,  96,  97,  129 

Freight  on  consigned  goods,  146 

Furniture  and  fixture!,  123,  127, 
128,  129,  133 

General  expense,  94 

General    ledger     (See    "General 
Ledger"  under  "G") 

Horses,  wagons  and  motors,  133 

Income,  156,  157 


Individual,  142,  154 

Interest,  142 

Interest  accrued  on  bonds,   150- 

152 

Interest  and  discount,  146 
Land  and  buildings,  130,  131 
Legal  expense  deferred,  145,  146 
Loans  payable,  152 
Machinery  and  tools,  132 
Moving  expense,  146 
On  the  credit  side,  148-158 
Organization  expense,  145,  146 
Patents,  trade-marks,  copyrights 

and  good-will,  134 
Payable,  97,  103,  153,  *54 
Petty  cash,  96 
Premium,  145 
Profit  and  loss,  145,  158,  165,  166, 

174 

Property,  127,  129,  132 

Receivable,  138-141,  153,  154,  168 

Royalties,  n,  147,  157 

Securities  owned,  133 

Someone  to  keep  and  audit,  5,  7 

Subscribers  to  capital  stock,  142 

Treasury  stock,  133,  134 

Unexpired  insurance,  160,  161 

Unpaid,  153 

Which  require  analysis,  131-134 
ADJUSTER,  82,  83 
ADJUSTMENTS  : 

Classification  of,  159 

Illustration  of,  160,  161 

Meaning  of,  159 
ADVERTISING,  146 
AMORTIZATION,  156,  157 
ANALYSIS  (Sea  "Analyzing  of  Ac- 
counts") 

ANALYSIS  PAPER,  25,  26,  42,  43,  44, 
46,  53,  54,  93,  94,  106,  123,  165 


Index 


ANALYZING  OP  ACCOUNTS: 

Definition  of  term,  121 

Importance  of  details  in,  126 

Must  be  carefully  done,  123 

Objects  of,  121,  130 

Procedure  to  be  followed  in,  123, 

124,  125 

APPROPRIATIONS,  EXCESSIVE,  9 
ARTICLES  OF  INCORPORATION,  61 
ASSESSMENTS  : 

Distinguished  from  taxes,  131 

What  may  be  covered  by,  131 
ASSET,  14,  in,  121,  122 
ASSOCIATIONS  : 

Checks  of,  82,  83 

Receipts  from,  75,  77 
AUDITED  VOUCHERS,  103 
AUDITED  VOUCHER  RECORD,  103 
AUDITING  : 

As  an  art,  2 

Committee,  63 

Compared  with  accountancy  and 
accounting,  2,  53 

Definition  of,  I,  2,  13 

Discussion  of,  from  professional 
point  of  view,  16 

Occasions  for,  4,  5,  8 

Of  cash  book,  71 

Of  petty  cash,  98-101 

Principles  of,  2 

Professional  or  non-professional, 
2 

Reasons  for,  4 
AUDITS  : 

Balance  sheet,  14 

Complete,  13 

Conduct  of,  2 

Difference  between  examinations, 
investigations  and,  15 

Occasion  for  the,  8-12 

Of    a    municipality,    railroad    or 
bank,  71 

Order  to  be  followed  in  making, 
61 

Partial,  13,  14 

Period  covered  by,  37 

Preliminaries     preceding    begin- 
ning of,  1 6 


AUDITOR  : 

Attention  to  details  by,  54,  55 

Care  of,  in  handling  cash  checks, 
82 

Care  of  papers  and  books  by,  162, 
176,  177 

Certificate  of,  8,  9,  10 

Courtesies  extended  by,  to  em- 
ployes, 162,  163 

Examination  of  money  bags  by, 
36 

Functions  of,  2,  4 

Handling  of  cash  by,  33 

Handling  of  records  by,  34 

Inability  of,  to  verify  signature 
on  checks,  81 

Need  of,  5,  6 

Presence  of,  at  taking  of  inven- 
tories, 112,  113 

Professional  and  non-profession- 
al, 6,  13,  16 

Relation  between  client  and,  173 

Report  of,  12 

Services  of,  5,  6 

Test  of,  as  to  correctness  of  in- 
ventories, 113,  114 

Time  required  by,  47 

Working  conditions  of,  29,  30 

BALANCE  : 

Bank,  75,  85 

Importance  of  bringing  out,  clear- 
ly, 125 

In  individual  accounts,  142 

Of  books,  53 

Of  cash,  33-40,  100 

Old,  reduction  of,  141 

Verification  of,  136,  137,  138,  154 
BALANCE  SHEET: 

Audit,  14 

Definition  of,  14 

Grouping  of  accounts  on,  n 

Items  shown  on,  165,  167,  168,  174 

Representing  financial   condition, 

III,  112 

BANKS,  8,  9,  80,  81,  82,  83 
BANK  ACCOUNT: 
Error  in,  80 


188 


Index 


BANK  ACCOUNT — Continued 

Reconciliation  of  the,  78,  79,  83, 

84,  85,  89,  92 
BANK  CERTIFICATES,  25,  48,  49,  50, 

Si,  83 

BANK  STATEMENT,  78,  79 
BENEFICIARIES,  n 
BEQUESTS,  75,  76 
BOND  HOUSES,  12 
BONDS  : 

As  securities,  44,  133,  144 

Coupon,  149 

Coupons  on,  45 

Description  of,  44,  45 

Interest  on,  n,  45,  47,  74,  75,  147, 
149,  ISO,  151,  156,  157 

Method  of  recording,  44,  149-152 

On  credit  side,  148 

Outstanding,  149,  150 

Quotations  on,  45 

Redemption  of,  148 

Registered,  45,  46,  148,  149,  ISO, 
152 

Secured  by  mortgages,  148 
BONDS  AND  MORTGAGES: 

Definition  of  each  document,  46 

Insurance    on    mortgaged    prop- 
erty, 46,  47 

Interest  on,  147 

Method  of  recording,  46 

Mortgage  tax,  46,  47 
BONDHOLDERS,  8,  n 
BOOK  INVENTORY: 

Description  of,  108 

Difference   between   physical   in- 
ventory and,  108 
BOOKS: 

Audited   vouchers,    103 

Audited  voucher  record,  103 

Cash,  68,  69 

Commission  discount  register,  170 

Commission  register,  170 

Cost  ledger,  115 

Creditors'  ledger,  67,  68,  103,  106, 
135-140 

Customers'    ledger,    67,    68,    107, 
I35-I4I,   156 

General,   13 


General  cash,  66-69,  98 
General  journal,  67,  107 
General  ledger,  67,  68,  92,  94,  96, 

103,  106,  107 
List  of,  51,  52 
Original  entry,  13,  94 
Payroll  book,  66,  67 
Petty  cash,  66,  67,  68,  100,  101 
Purchase     journal     or     voucher 

register,  66,  67,  68,  70,  87,  102, 

103,  104,  105,  106 
Purchase  returns  and  allowances, 

66,  67,  68,  106 

Sales  book,  66,  67,  106,  156 

Sales  journal,  68 

Sales  return  and  allowances,  66, 

67,  68 

Voucher  record,  103,  104,  105,  106 
Voucher  register,  66,  67,  68,  70, 

87 

When  ready  to  be  audited,  53 
BUILDINGS  : 

Betterments  to,  132 

Depreciation  to,  132 

Insurance  on,   132 

Purchase  price  of,  132 

Repairs  to,  132 
BURY,  Definition  of  term,  120 
BUSINESS,  Phase  of  a,  14 
BY-LAWS,  62 

CASH: 
Count  of,  method  of  recording, 

33-41 

Discrepancy  in,  35 

Examination  of,  by  auditor,  36 

Handling  of,  33,  34,  39 

Received,  receipts  from,  71 

Sales,  receipts  from,  71 

Segregation  of,  39 

Working  back  the,  40 
CASH  ACCOUNT,  55 
CASH  BOOKS: 

Auditing  of,  71 

Balance  in,  34,  39,  40,  71,  85,  91 

Cash  receipts,   152 

Checking  between  ledger  and,  92, 
93,  94  95 


189 


Index 


CASH  BOOKS — Continued 
Credit  side  of,  78 
Discussion  of,  68 
Errors  in,  91 

Footing  of,  18,  88,  89,  90,  91,  92 
Function  of,  69,  71 
General,  66-69,  98 
Handling  of  bonds  in,  149,  150, 

151 

Holding  open  of,  95 

In  place  of  check  book,  79 

Of  an  institution,  87,  88 

Of  bank  or  broker,  70 

Petty,  66-68 

Ruling  of,  70 

Scrutiny  of,  155 

Varieties  of,  68-70 

Vouching  of,  68 
CASH     DISBURSEMENTS,     Vouching 

the,  78-80 

CASH  RECEIPTS,  152,  153,  165 
CASH  RECEIVED: 

Methods  of  recording,  73,  74 

Receipts  from,  71 
CASH  REGISTER,  72 
CASH  SALES: 

Entries  of,  72,  73 

Receipts  from,  71 

Verification  of,  72 
CASHIERS,  35,  37,  40 
CAPITAL,  8 
CAPITALIZATION   OF    EXPENSE,    121, 

122,  159,  160 

CAPITAL  STOCK,  61,  155,  156 
CERTIFICATES  : 

As  to  correctness  of  inventories, 
109 

For   reports,    165,    172,    173,    174, 

175 

Of  Bank  showing  balance,  50,  51 

Of  Deposit,  47 

Of  Incorporation,  61 

Of  Indebtedness,  47 
CHARITABLE   ORGANIZATIONS,   9,    10 
CHARGE  SALES,  156 
CHARTER,  61 
CHECK  BOOK,  79 
CHECKING,  33,  34,  40,  121,  122 


CHECKING  POSTINGS,  66,  68,  92,  93, 

94,  95 
CHECKS,  33,  39 

As  receipts,  86,  87 

Cancelled,  79 

Cashing  of,  80,  81 

Checking  of,  79,  91 

Depositing  of,  92 

Drawn  to  "Cash,"  81,  82 

Endorsements  on,  80-83 

Reimbursement,  97 

Returned,  arrangement  of,  78,  79 
CLASSIFICATION,  13,  56 
CLIENT,  15,  16,  28,  34,  48,  173 
COAL,  108,  114,  115 
COLLECTION  BOXES,  75,  76 
COLLECTORS,  75 
COMMENTS   ON    REPORTS,    165,    167, 

168,  170,  171,  172,  176 
COMMISSION     DISCOUNT    REGISTER, 

170 

COMMISSION  REGISTER,  170 
COMMISSIONS  EARNED,  157,  158,  169, 

170 

COMPTOMETER,  72,  119 
CONTRACTS,  16,  63 
CO-PARTNERSHIP,  5 
CO-PARTNERSHIP  AGREEMENTS,  63 
COPYRIGHTS,  134 
CORPORATIONS  : 

Minutes   of   directors   or   stock- 
holders of,  61 

Officers  of,  6,  62 

Stock  books  of,  156 
COST  LEDGER,  115 
COST  SYSTEM,  115,  116 
COUPON  BONDS,  149 
COUPON  DEPOSIT  ACCOUNT,  152 
COUPONS  ON  BONDS,  45,  150,  151 
CREDIT,  8,  53,  54 
CREDIT  MEN,  138,  139 
CREDITORS,  8,  11 
CREDITORS'  LEDGER,  67,  68,  103,  106, 

153,  154 
CRITICISM,  1 68,  169 

CUMULATIVE    DEPARTMENT    COSTS, 
116 


190 


Index 


CUMULATIVE  MATERIAL  UNIT  COST, 
116 

CUMULATIVE    UNIT    LABOR    COSTS, 
116 

CUSTOMERS'  CASH  BOOK,  68 
CUSTOMERS'  LEDGER: 

Aging  of,  138,  139,  140,  141 

Agreement   with   controlling   ac- 
count, 135 

Checking  postings  of,  68,  69 

Classification  of,  138 

Collection  of,  138 

Face  value  of,  135 

Footing  of,  67 

Study  of,  141 

Trial  balance  of,  135 

Verification  of  statements  of,  136, 
137 

DEBITS,  53,  54 

DEPARTMENT  STORE,  13 

DEPARTMENTAL  COST  OF  GOODS,  116 

DEPARTMENTAL  UNIT   COSTS,    116 

DEPRECIATION,  129,  133 

DETAILED  MEMORANDUM  BOOK,  72 

DIARIES,  27 

DIRECTORS,  7,  n,  61,  63 

DISBURSEMENTS  : 
Entry  of  items  of,  39,  40 
Footing  of,  18,  92 
Invoices  for,  154,  155 
Of  an  institution,  87,  88 
Petty  cash,  96,  97,  99,  101 
Statements  of,  as  exhibits,  164 
Supported  by  checks,  86 
Supported  by  signed   receipts,  86 
Vouching   of,    18,   78-83,   86,   87, 

89,  9i 
DISCOUNT  : 

In  Sales  Book,  106,  107 

In  Voucher  record,  105,  106 

On  Bonds,  145 
DISTRIBUTION,   87,   88,  '97,  99,   100, 

106,  107 
DIVIDENDS  : 

Declared  and  unpaid  account,  152 

Keeping  down  of,  9,  II 

On  stocks,  71,  75,  *57 


DIVIDEND  NOTICES,  75 
DONATIONS,  75,  76 
DRAFTS,  Interest  on,   142 
DUES,  75 

DUPLICATE  INVOICES,  14 
DUPLICATE  SALES  SLIPS,  72 

EFFICIENCY  WORK,  2 
EMPLOYES,  Bonded,  n 
ENDORSEMENT  RELATION,  153 
ENDOWMENT  FUND,  170,  171 
ENGAGEMENTS,  15,  16,  17,  18,  19,  20 
ENGAGEMENT  BLANK,  16,  17,  18,  19, 

21 

ERRORS  (See  "Adjustments") 

EVIDENCES  OF  SYNDICATE  PARTICI- 
PATIONS, 47 

EXAMINATIONS,  2,  14,  15 

EXCHANGE,  158 

EXECUTIVE  COMMITTEE,  61,  63 

EXHIBITS,  165 

EXPENSE,  8,  9,  27,  96,  97,  121,  122, 
131,  132,  145,  146,  155,  159,  160 

EXPENSE  FUNDS,  22 

EXPLANATION  COLUMN,  34 

EXPLANATIONS  OF  POSTINGS,  127 

EXTENSIONS,  119 

FIDELITY  COMPANIES,  II 
FINANCIAL  STATEMENTS,  10,  13,  14 
FINANCIAL  TRANSACTIONS,   i,  2,  7, 

13 

FINISHED  GOODS,  108 
FISCAL  AGENT,  151,  152 
FIXED  FUNDS,  97,  100 
FLUCTUATING  FUNDS,  07 
FOLLOWING  THE  INTEREST  THROUGH, 

156,  157 
FOOTING  : 

Meaning  of,  66,  67 

Of  Cash  book,  18,  88,  89,  90,  91, 
92 

Of  inventories,  119 
FREIGHT  ON  CONSIGNED  GOODS,  146 
FUNDS  : 

Building,  171 

Cash,  37 

Endowment,  169,  170 


191 


Index 


FUNDS — Continued 
Expense,  22 
Fixed,  97,  100 
Fluctuating,  97 
Petty  cash,  37,  97 

FURNITURE  AND  FIXTURES,  122,  127, 
128,  129,  133 

GENERAL  CASH  BOOKS,  66-69,  72,  98 
GENERAL  EXPENSE  ACCOUNT,  94 
GENERAL  JOURNAL,  67,  68,  107 
GENERAL  LEDGER: 

Abstracting  the,  94 

Analyzing  of,   121 

Column,  127,  128 

Controlling  account  in,   56,   153 

Footing  of,  67 

Grouping  of  accounts  in,   n 

Importance  of,  52 

Items,  in  cash  book,  70 

Mechanical  work  in,  107 

Method  of  operating,  97 

Paging  of,  55 

Petty  cash  account  in,  96 

Subsidiary  accounts  in,   55 

Taking  trial  balance  of,  52,  53,  54 
GOLD,  36 
GOODS: 

Finished,  108,  114,  115 

In  process,  108,  114,  115 

In  transit,  108,  114,  115 

Out    on    consignment,    108,    114, 
"5,  146 

Out   on    memorandum,    108,    114, 

"5 
GOOD- WILL,  134 

HORSES,  WAGONS  AND  MOTORS  AC- 
COUNT, 133 

INCOME,  13,  156,  157,  164,  173 
INCORPORATORS,  61 
INDENTURES,  141 
•INDIVIDUAL  ACCOUNTS,  154 
INSTITUTIONS  : 

Receipts  from,  75,  77 

Vouching  disbursements  of,  87 
INSURANCE,  unexpired,  160,  161 


INSURANCE  COMPANIES,  8 
INSURANCE  POLICIES,  46,  131,  132 
INTEREST  : 

Account,  142,  146 

Accrued,  150-152,  156,  157,  160 

And  discount  account,  146,  147 

Checks,  150,  151 

Earned,   157 

Following  the,  through,   156,  157 

On  bank  balances,  71,  75 

On  bonds    (See  "Bonds") 

Purchased,  156,   157 
INVENTORIES  : 

Auditor  present  at  taking  of,  112, 
113 

Certificate   as   to   correctness   of, 
109,  no,  113 

Classes  of,  108 

Extensions  of,  119 

Footing  of,  119 

Matters    to    be    understood    by 
auditor  in  examining,   108,  109 

Plan  for  taking,  113,  115,  116 

Prices  used  on,  no,  in,  114,  115, 
116,  117,  118 

Test  of  auditor  as  to  correctness 
of,  113,  114 

Valuation  of,  no,  ill 

What  is  included  in,  108 
INVESTIGATIONS,  2,  14,  15 
INVOICES  : 

Duplicate,  14 

For  cash  disbursements,  153,  154 

Individual,   14 

In  sales  book,  106 

In  voucher  register,  103,  104 

Sales,  14 
I.O.U.'s,  33,  39 

ITEMS,  open,  106 

JOINT  VENTURE,  5,  27 

JOINT  VENTURE   AGREEMENTS,   63 

JOURNAL  ENTRIES,  56,  58,  107,  159, 
166 

JOURNAL  PAPER,  25,  33,  61,  83,  161, 
165 

JOURNAL  PURCHASE    (See    "Pur- 
chase Journal") 


192 


Index 


LABOR,  116,  117,  118 
LAND: 

Improvements  on,  130,  131,  132 

Purchase  price  of,  130 

Sales  of  part  of,  130 
LAND  AND  BUILDINGS  ACCOUNT,  130, 

167,  172 

LEGACIES,  75,  76 

LEGAL  EXPENSE  DEFERRED,  145,  146 
LETTER: 

Of  introduction,  21 

Requesting  amount  on  deposit  at 

bank,  49,  50,  51 
LIABILITIES,  14 
LOANS  PAYABLE,  152,  153 

MACHINE  LISTS,  78,  79 
MACHINERY   AND   TOOLS   ACCOUNT, 

132 

MANAGEMENT,  9,  n 
MANUFACTURING  ORGANIZATION,  71 
MATERIAL  UNIT  COST,  115-118 
MATERIALS  AND  SUPPLIES,  108,  in, 

112,    114,    115 

MECHANICAL  WORK,  Classes  of,  66 
MEETING,  ANNUAL,  Date  of,  63 
MEMBERSHIP  ASSOCIATIONS  OR  SO- 
CIETIES, 6 

MEMORANDUM  BOOK,  100 
MERCANTILE  ORGANIZATION,  71 
MINUTES  : 

Illustration  of  abstract  of,  63-65 

Of  directors,  61,  63 

Of  executive  committee,  61,  63 

Of  special  committees,  61 

Of  stockholders,  61,  63 

MISCELLANEOUS    RECEIPTS,    71,    74, 

75,  76,  77 

MISCELLANEOUS  SECURITIES,  47 
MODERN    BUSINESS    ORGANIZATION, 

3,  4 

MORTGAGES  : 
As  securities,  133 
Definition  of  document,  46 
Reading  of,  important,   142,   143. 

145,  148 

Special  provisions  of,   148 
Tax,  46,  47 


MORTGAGE  TAX,  46 
MOVING  EXPENSE,  146 

NOTES  PAYABLE,  152,  153 
NOTES  RECEIVABLE,  33,  37,  56,  71 
Count  of,  42,  43 
Forms  of,  42 
Indorsement  on,  43 
Interest  on,  43,  142,  147 
Method  of  recording,  42 

OIL,  108,  114,  115 
ORGANIZATIONS  : 

And  management,  criticism  of,  a 

Charitable,  9,  10 

Manufacturing,  71 

Mercantile,  71 

Modern  business,  3,  4 

Trading,  71 

ORGANIZATION  EXPENSE,  145,  146 
OVERHEAD,  116-118 

PACKING  MATERIAL,  108,  114,  115 

PARTNERS,  5 

PASS  BOOK,  48,  51,  78,  80,  91 

PATENTS,  134 

PATIENTS,  pay  and  dispensary,  75 

PAYABLE,   ACCOUNTS,   97,   103,   153, 

154 
PAYING-TELLER,  80,  81 

PAYROLL,  66,  67,  82,  86,  107 

PETPY  CASH  : 

Accounts,  handling  of,  96,  97,  98 

Auditing  of,  98-101 

Books,  66-68,  100,  101 

Funds,  37,  97,  98,  101 

Reports,  101 

PHASE  OF  A  BUSINESS,  14 
PHYSICAL  INVENTORY: 

Description  of,   108 

Difference  between  book  inven- 
tory and,  108 
POLICIES,  46,  131,  132 
POSTAGE,  108,  114,  115 

POSTING  OF  TOTALS: 
In  Voucher  record  and  Purchase 
Journal,  106 


193 


Index 


POSTINGS  : 

Abstract  of,  106 

Checking  of,  66,  68,  92,  93,  94, 
95,  107 

Explanations  of,  126,  127 

Mistakes  in,  160 
PREMIUM,  145 

PRESENTATION  OF  REPORTS,  165,  175 
PRICES   ON   INVENTORIES,    no,    in, 

"4,  "5 

PRINTING,  108,  114,  115 
PROFIT  AND  Loss,  13,  112,  130,  131 
PROFIT  AND  Loss  ACCOUNT,  145,  158, 

165,  166,  174 
PROFITS: 

Determination  of,  5 

Reduction  of,  9 

Relation  of,  to  interest  and  divi- 
dends, II 

Sharing  of,  5 
PROPERTY  ACCOUNT,  127 
"PULLED"  VOUCHER,  127 
PURCHASE  JOURNAL   (OR  VOUCHER 
REGISTER),  87,  127: 

Checking  of  postings,  68,  104 

Difference  between,  102,  103 

Footing,  67,  104 

Handling  of  bonds  in,  149,  150 

Invoices  in,  102,  103 

Method  of  operating,  102,  103 

Uses  of,  70 

Vouching  of,  necessary,  66 

PURCHASE    RETURNS   AND   ALLOW- 
ANCES, 66,  67,  68,  106 

RBCAPTTULATION  SHEET,  85 
RECEIPTS  : 

Checks  as,  86 

Depositing  of,  92 

Entry  of,  39,  40 

For  payment  on  account  of  cap- 
ital stock,  47 

Miscellaneous,  71,  74,  75-77 

Verification  of,  71,  77,  86,  91 
RECEIVABLE,  ACCOUNTS: 

Aging  of,  139,  140 

Checking  of,  167 


Inclusion  of,  in  accounts  payable 
ledger,  154 

Trial  balance  of,  153 

Value  of,   138 
RECEIVERS,  n 

RECOMMENDATIONS,  168,  169,  170 
RECONCILIATION  OF  BANK  ACCOUNT, 

78,  79,  83,  84,  85 

REGISTERED  BONDS,  45,  46,  148,  149 
REIMBURSEMENT  CHECK,  97,  98 
REMITTANCE  SLIP,  74 
REPORTS: 

Expense,  22,  25 

Extract  from,  170,  171 

Form  of,  175,  176 

Parts  of,  165,  166,  167 

Petty  cash,  101 

Preparation  of,  162,  165,  172,  176 

Time,  22-24,  27 

Typing  of,  166,  167,  176 

Written,  6,  7 
RESERVE,  in 

RESERVES,  SUPERFLUOUS,  9 
RESULTS,  14 
ROYALTIES,  n,  147,  157 

SALES: 

Book,  66,  67,  106,  107,  156 

Invoices,  14,  106,  160 

Journal,  68 

Records,  14 

Returns  and  allowances,  66-68 

Slips,  72 

SCHEDULES,  168,  169 
SCRAP,  1 08,  109,  114  118 
SCRIP,  47 
SECURITIES,  33,  37 : 

Bonds  as,  44,  133 

Cancelled,  144 

Certificates  of  deposit  as,  47 

Certificates  of  indebtedness  as,  47 

Definition  of,  43 

Evidences  of  syndicate  participa- 
tion as,  47 

Kept  alive,  144 

Method  of  recording,  43 

Mortgages  as,  133 

Owned,  133 


194 


Index 


SECURITIES— Continued 

Receipts  for  payment  on  account 
of  capital  stock  as,  47 

Sales  of,  160 

Scrip  as,  47 

Stocks  as,  43,  44,  133 

Subscriptions  as,  47 

Warehouse  receipts  as,  47 
SILVER  DOLLARS,  39 
SINKING  FUNDS: 

Beneficiaries  under,  n 

Certificate  as  to  amount  of   de- 
posit, 143 

Qause,  142,  143 

Creation  of,  145 

Form  of,  143,  144 

Object  of,  144 

Reconciliation  of,   143 

Statement  covering  interest,   143 

Verification  of,  143,  144 

Where  deposited,  143 
STATEMENTS  : 

Bank,  78,  79,  80,  91 

Financial,  10,  13,  14 

For  reports,  165,  166,  167 
STATEMENT  or  INCOME  AND  PROFIT 

AND  Loss,  13,  14 
STATIONERY,  108,  114,  115 
STOCK  CERTIFICATES,  43,  44,  155,  156 
STOCK  IN  TRADE,  108,  109,  no,  114, 

"5 

STOCK  LEDGER,  156 
STOCK,  TAKING,  112 
STOCKHOLDERS,  6,  7,  9,  10,  n,  61,  63 
STOCKS: 

As  securities,  43,  133 

How  recorded,  44 
SUBSCRIBERS  TO  CAPITAL  STOCK,  10, 

142 

SUBSCRIPTIONS,  47,  75 
SUB- VOUCHERS,  18 
SUGGESTIONS,  168,  169 
SUMMARY  OF  ANALYSIS,   128,   146, 

147,  159 

SURPLUS,  130,  131 
SYSTEMS,    devising    and    installing 

Of,  2 


TAX: 

Distinguished 


from    assessment, 


Mortgage,  46 
Receipts,  47,  131 

TESTING,  14 

TICKETS,  22 

TITLK  INSURANCE  POLICIES,  131 

TOOLS,  AND  MACHINERY,  ACCOUNT, 
132 

TOTAL  MATERIAL  COST,   116 

TOTAL  LABOR  COST,  116 

TOTALS: 

Discount  in  sales  book,  106,  107 
Posting  of,  in  sales  book,  107 
Posting    of,    in    voucher    record 
and  purchase  journal,  106 

TRADE  DISCOUNT: 
In  sales  book,  106,  107 
In  voucher  record,  105,  106 

TRADING  ORGANIZATIONS,  71 

TRADE-MARKS,  134 

TRANSACTIONS,  14 

TRANSCRIPT    OF    LEDGBR    ACCOUNT, 
123,  126 

TREASURY  STOCK  ACCOUNT,  133,  134 

TRIAL  BALANCE: 
Arrangement     and     labeling     of 

sheets  of,  53,  54 
Cash  account  part  of,  55,  56 
Illustration  of,  57 
Method  of  taking  off,  53,  55,  56 
Necessity  of  going  over,  130,  159 
Of  accounts,  56 
Of  accounts  payable,  153 
Of  accounts  receivable,  153 
Of  Creditors'  ledger,  154 
Of  Customers'  ledger,   135 
Of  General  ledger,  52,  107 
Of  stock  ledger,  156 
Reference   to,    in   closing    audit, 
176,  177 

TRUSTEES,  n 

UNDERWRITERS,  12 

UNEXPIRED     INSURANCE     ACCOUNT, 

160,  161 
UNITS  OF  STOCK,  109 


195 


Index 

VOUCHERS,  18,  33,  39,  87,  88,  97,  127,  Method  of  operating,  103 

160  Uses  of,  70 

VOUCHER  RECORD,  103  Various  other  names  given,  103 

VOUCHER  RECORD  ACCOUNT,  106  Vouching  of,  necessary,  66,  104, 

VOUCHER    REGISTER    (or    Purchase  105 

Journal),  87,  97,  127: 

A-rangement  of  vouchers,  105  WAREHOUSE  RECEIPTS,  47 
Checking  of  postings,  104,  121 

Difference  between,   102,  103  WASTE'  Io8'  If*  "« 

Footing,  104  WORKING  BAG,  27 

Method  of  handling  invoices  in,  WORKING  SHEET,  56,  166 

103,  104 


196 


UNIVERSITY  OF  CALIFORNIA  LIBRARY 

Los  Angeles 
This  book  is  DUE  on  the  last  date  stamped  below. 


c^p 


T&R. 


Form  L9-32m-8,'57(.C8680s4)444 


Library 
Graduate  School  of  Business  Administration 

Un^  '-rsity  of  California 
Los  Angeles  24,  California 


if- 


A  •"•  •"•nun  IIII!  IIII  || 

000178684     7 


SOUTHERN 


. 
LOS   ANGELES, 


